Chapter 5 – Analysing Point and Figure Charts

When faced with analysing a Point and Figure chart, there are a number of thought processes you need to go through. This chapter takes you through those processes so that you can make the decisions that affect the look and feel of the Point and Figure chart that you draw, using two stock indices: the NASDAQ Composite Index and the FTSE 100 Index.

Before you draw your Point and Figure chart you must decide what data you intend to use and then what box and reversal size, because this affects the look of the chart and any subsequent analysis. To do this you need to consider a number of things:

Are you taking a long-, medium- or a short-term view?
Do you wish to use I -box, 3-box or any other reversal chart?
What sort of price moves do you wish to isolate?
How sensitive do you wish to make the Point and Figure chart?
Do you wish to expose or hide the instrument’s volatility?
What is the range of the past prices?
What drawdowns are you prepared to accept before a reversal is indicated?

Even knowing the answers to these questions, an experienced Point and Figure analyst may still not instantly know what to choose and will, therefore, draw a ‘tester’ chart first. Looking at the tester chart helps you to decide what adjustments to make to show more or less sensitivity.

The reversal size

The first decision you should make is the reversal, that is the number of boxes required to change from a column of Xs to a column of Os or vice versa. Remember, changing the reversal changes the look of the chart completely. Refer to the l O x 1 and l O x 3 charts constructed in chapter 2. Remember, also, that the reversal relates to column changes. The smaller the reversal, the more column changes will occur. Increasing the column changes can give you more information but it can also introduce more volatility and noise into the chart.

A medium-term trader – someone who expects to hold for 1 to 6 months – would certainly use a 3-box as well as a I -box reversal chart. Medium-term traders are concerned with remaining within the trend and not being coaxed out by small countertrend moves, both of which 3-box charts are good for. In fact, 3-box reversal charts are the first port of call for all newcomers to Point and Figure and are highly recommended. That is not to say that a medium-term trader would not use a I-box chart, some would because they are also useful. In fact, as you will discover, it is wise to look at a number of different Point and Figure charts at the same time., Chart 5 – 1 shows a 3-box reversal chart of the S&P 500 Index and Chart 5 -2 shows a I -box reversal chart. The letters A-B show the trend since March 2003 for reference.

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Chart 5-1 : 1 0 x 3 of the S&P 500 Index showing a 3-box reversal chart

Notice how the 3-box chart is a condensed version of the I-box chart. Both charts are however, useful to the medium-term trader. The I-box chart contains information and patterns that are not visible in the 3-box chart. In fact, essentially, you can regard I-box and 3-box charts as being two completely different methods of charting. Not only is their construction different, but, as you will see, their interpretation is different as well.

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Chart 5-2: 1 0 x 1 of the S&P 500 I ndex showing a 1 -box reversal chart

What about the short-term trader? The short-term trader will hold until any minor trend change occurs because they tend to be trading on margin and cannot afford to accept drawdowns. The length of the hold period ranges from hours to a few weeks. Short-term traders should always include a I-box reversal chart as well as a 3-box chart, perhaps even a 2-box chart. The I -box chart is essential for seeing support and resistance levels, and where most of the price activity is taking place. Ideally, this should be drawn using tick data, where every trade is recorded and plotted. But the short-term trader also needs to know the trend, so 3-box charts, which condense the price movement and give more emphasis t� the prevailing trend by the asymmetric filter, are used as well.

The following two charts show the FTSE 1 00 Index 1 x 1 (Chart 5-3) and 1 x 3 (Chart 5-4) using tick data. The first thing you should notice is that the 1 x 1 chart has many more changes from X to 0 and 0 to X. There is nothing wrong with this; in fact, it gives you a lot of information about the trading taking place. The consequence, however, is that the chart shows a fraction of the time period that is shown in the 1 x 3 chart. Actually, this is not strictly true. It is just that because the XS and Os are a physical size, it is not possible to show them all at one time without making them very small. Chart 5-5 is the same 1 x 1 chart but the XS and Os have been reduced in size so that all the trading over the period can been seen.

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Chart 5-3: 1 x 1 tick chart of the FTSE 1 00 Index

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Chart 5-4: 1 x 3 tick chart of the FTSE 100 Index

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Choosing the correct box size

Having decided on the reversal, the next thing to decide on is the box size. Choosing the correct box size is vital for good Point and Figure analysis and it is not as difficult as it sounds. It does need to be logically thought through, although some make it out to be a bigger issue than it is. It requires a complete understanding of what the Point and Figure c�art represents and what it is that you are trying to extract from the chart. There are, of course, rules of thumb to do this, but having to rely completely on a rule of thumb demonstrates a lack of understanding as to what the Point and Figure chart is showing you.

To choose the box size, you must again consider your time horizon. This may sound strange when it is known that Point and Figure charts don’t take any account of time, but altering the box size increases or decreases the sensitivity of the chart and hence has the effect of altering the time horizon of the chart. You have seen this already with the reversal size. For example, a medium-term trader ofthe FTSE 1 00 Index may decide that a 50 point or 25 point box size would be about the right sensitivity, but a day-trader would find them impossible to use. The thinking is as follows:

A 50 x 3 Point and Figure chart (Chart 5-6 opposite) means that every 50 point movement in the direction of the trend is plotted and every reversal of 150 (3 x 50) is plotted. Anything below these values is ignored. With the index at around 4500, that is a reasonable record of the medium trend. Furthermore, a 150 point, or 3% reversal is not an unreasonable amount for a medium-term trader to bear before a column change is signalled. It is, however, totally unacceptable for a short-term trader.

You will ieam later that it is best to use at least two, preferably three, different Point and Figure charts when doing your analysis. In drawing more than one, you will see things in one that you may not see in another. Using more than one chart helps to refine your timing. Where the longer-term chart may have generated a buy signal, the shorter-term chart may be signalling a small correction, allowing you to wait for the short-term chart to signal a resumption of the uptrend.

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Chart 5-7 is a 25 x 3 chart ofthe FTSE 100 Index. The uptrend move from point A to B, shown on both charts, demonstrates the difference. In the 50 x 3 , the move from A to B has taken place in 6 up legs; in the 25 x 3, it has taken 16. The reason, obviously, is that the 25 x 3 chart plots 25 point moves in the direction of the trend and 75 point moves against the trend.

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Chart 5-7: 25 x 3 of the FTSE 100 Index

The 25 x 3 chart does give more information than the 50 x 3, but do not assume that you can simply keep reducing the box size to gain more and more infonnation. There will be a point when the chart becomes unreadable. ‘Unreadable’ is a subjective condition, but the more you use a Point and Figure chart, the easier you will find it.

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You will have noticed that all the above charts are constructed using the end-of-day close price rather than the daily high or low. It is argued that the reason for using high/low charts is that they cater for the trading range, which close only charts ignore. That is true, but that is only of importance if intra-day data is not available. Remember high/low daily charts still take only one price per day, according to a set of rules which determine whether the high or the low should be used. So, in constructing a daily chart with high/low data, you take the high or the low, but not both, and consequently you take no account of whether the price hit the high or the low first. You will also recall that there is a flaw in the construction rules when the high and low produce a new box as well as a reversal, but only one can be used. That is not to say that you should ignore high/low charts. They do add an extra dimension to Point and Figure construction and analysis. Sometimes daily high/low charts will show patterns like the W-shaped bottom (circled) in Chart 5-9 that cannot be seen in daily close only charts, as demonstrated by the circled area in close only 5 x 3 Chart 5-8 and high/low Chart 5-9.

Chart 5-9: 5 x 3 (h/l) of the FTSE 1 00 Index

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What looks like nothing more than a decline and rise in the daily close only Chart 5-8 shows up as a W formation bottom followed by a double-top breakout in Chart 5-9. From this, a horizontal as well as a vertical count may be obtained.

Daily high/low charts are fme ifyou do not have access to intra-day data; however, ifyou do, you are far better off drawing your chart using the close price at the end of every hour, instead of the high or low at the end of the day. So there comes a point when the short-term trader can no longer operate on daily data, and a single price per day and a switch to intra-day data is required.

Chart 5-8 and Chart 5-9 are constructed by taking one price per day at the end of the day. Although Chart 5-9 shows more information, it is really just a proxy for using intra-day data. Most importantly, it takes no account of the order in which the high and low occurred, and, in fact, only takes the high or the low – not both. Short-term traders need to know what is going on during the day. They need to know how the instrument has traded, where the intra­ day support and resistance levels are and in what order highs and lows were hit, hence the use of intra-day data.

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Choosing your data time series

The original Point and Figure charts were constructed using tick data, but, as tick data was difficult to obtain, many Point and Figure chartists started using the price at the end of the day. Data is not limited to tick and end-of-day; there are other time series such as weekly, as well as a number of intra-day interval data series, such as hourly, 15 minute, 5 minute etc., where the price is summarised into hourly, 15 minute or 5 minute high, low and close.

The use of weekly data is unusual, however, even when taking a long-term view. Taking only one price per week to construct your Point and Figure chart leaves out a lot of important information. The purpose of using weekly data is to avoid minor, often false, Point and Figure signals, but if you draw a weekly Point and Figure chart and keep the box size the same, you will get many of the same false signals that are present in the daily Point and Figure chart. You are, therefore, better off increasing the box size of your daily chart than switching to weekly. At least that way, your chart is constructed with five data points per week instead of only one.

Moving to intra-day data where more than one data point is taken per day widens the choice considerably, because not only are you able to choose different box sizes, but also different time series. For example, a 5 x 3 using hourly data allows 8 prices per day to be taken into account in the construction. Using 5 minute data allows 96 price changes to be used. What happens is that charts that were not helpful with daily data become readable again when intra­ day intervals are used. The column lengths shorten because the thrusts are not uninterrupted.

The circled area in the daily 5 x 3 Chart 5-9 is shown in the hourly 5 x 3 Chart 5-10. Notice immediately how much more information you obtain from the chart, even more than the daily high/low Chart 5-9. The chart has a good ‘look and feel’ about it. Where the daily high/low chart showed a double-top breakout, the hourly chart shows a triple-top breakout, which indicates that three attempts, not two, were made at breaking out.

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Chart 5-10: 5 x 3 (60 minute) of the FTSE 100 Index

Remember that a close only hourly chart may not pick up the actual high and low of the day, because the price may not close at either of these extremes at the end of each hour. You could, therefore, draw your hourly chart using the end of hour high or low as shown in Chart 5 – 1 1 . As you can see there is even more detail.

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You don’t have to stop there; a shorter-tenn view may be obtained by moving to 1 minute and eventually, tick data to extract as much infonnation as you require.

Log scale charts

Don’t forget that you may also use a percentage box size, which provides a log scale chart. There is no rule to follow as to whether an arithmetic points box size is better than a logarithmic percentage box size, except to say that log scale provides no benefit when shorter-tenn charts are being considered. This is because the change in logarithmic box size from one level to the next is not significant.

When using percentage boxes, however, you should always start with 1 % for the medium­ tenn, 0.5% for the shorter-tenn and 2% for the longer-tenn on daily charts. With intra-day charts, you should start with a 0. 1 % box size, except tick charts, which should always use an arithmetic box size. This is discussed in more detail below.

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Summary

To summarise, therefore, only you can decide the data series a s well a s the box and reversal size you require. Both the box size and the reversal are dependent on what it is you wish to extract from the chart.

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Decide on the reversal first. Short-term traders use I-box and 3-box reversal charts.

Medium-term traders use 3-box, and perhaps I-box, reversal charts. Long-term investors use 3-box, and perhaps 5-box, reversal charts

Next is the box size. Decide whether you require log or arithmetic charts. Draw both if you are not sure.

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If you intend to use an arithmetic scale, start with a box size which is 1 % of the latest price. Round up the box size to one of the standard sizes, which are: 1 , 2, 3 , 5, 10, 15, 20, 25, 50, 100, 250, 500 etc. Ifyou are looking at currencies or low priced shares, you would use 0.5, 0.25 0.2, 0. 1 , 0.05, 0.025 etc. If you are looking at an instrument that trades in narrow range, then choose 1 % of the trading range and round up the box size. The box size for bonds, for example, is best estimated based on the range rather than the last price. In both cases, do not use odd sizes such as 13 or 23, or any number between the standard sizes.

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Draw the chart and study it. Decide whether you are able to extract sufficient information from the chart.

If you intend to use a log scale, start with a box size of 1 %.

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Always decrease and increase the box size by one or two sizes to see if you get more information or a clearer picture from the changed box size.

You will nearly always need at least two, perhaps three, different Point and Figure charts to perform the analysis you need. Never assume one is enough.

As you go shorter-term, so you will need to move to intra-day data.

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Analysis of 3-box reversal charts

The purpose of this section is to talk you through the analysis of a 3-box chart example, so you may understand the thought process you need to go through when analysing any instrument using the 3-box method. Although it is similar for medium-term and short-term, an example of both is shown. In fact, what follows is a medium-term analysis, which then goes shorter and shorter-term so you can see how more information is exposed.

The FTSE 100 Index is chosen as the instrument for no other reason than that many watch this index and it has had a number of major trends. What is said below may be applied to any index, stock, commodity, future, currency etc. It is not the fact that it is the FTSE 100 Index that is important, but that it is the analysis of an instrument. The name could easily have been removed from the chart, but has been left to avoid suspicions that the data has been contrived. When following through the analysis, try to do it sequentially; try to place yourself in the position you would be at the time, without looking at the subsequent history to the right of your position on the chart. If necessary, place a blank sheet over the chart to hide any information to the right.

It is August 1998. Chart 5-12 is a 50 x 3 close only Point and Figure chart ofthe FTSE 100 Index at that time. A 50 point box is chosen because it is around 1 % of the current price rounded to the next sensible box size.

When faced with a chart like this, the first thing to do always is to ‘carve’ it up into bullish and bearish sections using 45° bullish support and bearish resistance lines. In fact, there are no bearish lines in this example, but that is not always the case. Trend line 1 is drawn at 45° from the 1 987 low. The first thing to notice is how the line was touched twice at points A and B thus reinforcing its strength as the main bullish support line. Notice the look of the chart ­ the long columns of Xs and short columns of Os. This is typical bull market action. The further away from the 45° support line, the longer the columns ofXs have to be. Notice also, the vertical count of4000 from the first move offthe 1 987 low was exceeded and, in fact, the price did not even pause at that target. This is further evidence of a strong bull trend. Remember achieving and exceeding targets is bull trend action. Notice that the count 3200 off the mini-bottom was also exceeded. An internal 45° bullish support line, 2, may then be drawn from the first reaction point above the main 45° bullish support line. This provides additional shorter-term support.

Notice the potential high pole just above point 2. This is an example where the price makes a high pole, but there is no follow-through. Some traders sell on a 50% retracement of the column of Xs by the column of Os. Some wait for a subsequent double-bottom sell. Either way, the double-top buy after the high pole must be taken to either re-open a closed position or add to an existing holding. The price continues to rise with one double-top after another. Each is an ‘add to position’ signal, which is one of the great advantages of Point and Figure

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charts. Each time the supply and demand come into equilibrium, re-assessment of the trend takes place and a new double-top buy, in this case, confirms and strengthens the trend.

At point C, the first double-bottom sell signal is issued and a mini-top is made. After the strong trend that preceded it, it would be wise to take some profits on this signal, although it is important to stress that, although the double-top and bottom signals are the basis for 3-box Point and Figure analysis, you should not take every single one, but in this case looking left provides no support.

Chart 5-12: 1st chart analysing the 50 x 3 of the FTSE 100 Index

The mini-top at C allows a downside vertical count of 3650 to be established, but notice that, although it was established, the count is never activated – further evidence of bull trend action. The reaction point following this top allows internal 45° trend line 3 to be drawn. At the same time, a new upside vertical count of 6 1 00 can be established and activated from the mini-bottom at point 3 . The risk-reward ratio of this count is 3 .4, based on a stop at 5000. Calculating the risk-reward ratio helps you to decide where to place your stop.

This 6100 count is achieved almost exactly and some sideways congestion takes place. Notice what happens. The length of columns of XS and Os start to balance one another out and a small triangle, marked in black, is formed around the 6000 level. If this happens after

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an uptrend, it indicates that distribution is taking place. Some would say that stock is being transferred from strong holders to weak holders. It could be either a top or a continuation pattern; it is impossible to say which at this stage. Remember, you do not have any information to the right of this pattern at the time. The odds, however, favour a continuation because the price is in a strong uptrend.

However, a double-bottom sell signal is generated from the triangle and although it is not an important sell signal because the price is in such a strong uptrend, it is just as well to weigh up the evidence. There has been the strongest ofuptrends; the upside count has been achieved with no other count pointing higher; a triangle has formed which has broken down, but looking left you can see support one box below, which may cause you to hold off selling until that level is broken. This is an example where not every double column signal has to be taken.

What follows is a triple-top buy signal with the price breaking above the blue horizontal line. It is a strong signal and it would be wrong to ignore it, but if you are already holding you may not add to existing but rather simply continue to hold, the reason being that there is no new target to aim for at this stage. It could be the continuation of the bull trend. The price, however, turns back again, pulling back into the pattern and setting up for a possible bullish catapult. That does not happen; instead, a multiple-bottom sell signal is generated, indicating that all long positions should be liquidated even though the price is still above the internal 45° trend line. In fact, what you have seen take place is a typical broadening pattern as discussed on page 147. These often occur at tops, where a continuation oftrend buy signal is given which is then reversed.

The price falls and consolidates just above trend line 3. At this stage, you have no idea whether it will continue down or tum around from the support it has found. A downside vertical count of 3900 may now be established from the top, although not yet activated. What follows is an attempt to form a double-top buy which does not materialise; instead, the price registers another double-bottom sell breaking down from an ascending triangle, at the same time breaking internal trend line 3 . All medium-term positions should be closed, although the price is still above the main bullish support line 1 . With the patterns that preceded the break of the trend line, and a downside count which is over 1 000 points away from the current price, there is now no reason to remain long.

The analysis continues using Chart 5-13 on page 292. Once the 45° uptrend line 3 is broken, internal bearish resistance line 4 may be drawn. The price is in a short-term downtrend defined by this line. Notice how the columns of Os are now longer than the columns of Xs, indicating the most significant bear trend action for some time.

What happens next is that the price falls towards 45° trend line 2 and forms a small bottom, and then thrusts back up, touching downtrend line 4. It pulls back and then re-asserts itself,

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breaking the bearish line 4 at the same time as giving a double-top buy signal. It is an indication to go long again. Notice that the downside count of 3900, which looked possible, has not been achieved – further evidence of a continuing bull market. Remember, achieving and exceeding upside counts, as well as the non-achievement of downside counts, provides evidence of bull market action.

From the upthrust column, a new upside vertical target of 7400 may be established. This is a good example of where you count the second column if the first is very short. In this case, the second column is a chart-changing column. Everything now looks in place for a bull run to 7400. The risk-reward ratio is a very favourable 7.0. To track the progress and provide internal support, 45° trend line 5 may be drawn from the reaction point at the break of trend line 4. Notice how the price rises within a channel contained by trend line 3 providing resistance, and trend line 4, providing support. It would make sense to decide to close some long positions on a breach of this channel. The price does eventually breach the channel at point D, giving a double-bottom sell signal, however all it does is come back to support on long-time established internal 45° trend line 2. At the same time, a new downside count of 4800 may be established from point D.

The price pushes away strongly from trend line 2, cancelling the new downside count, which reaffirms bull trend status, and at the same time giving a new double-bottom buy signal and breaking a small 45° downtrend line (not shown) from point D. It is a signal to go long again. At the same time a new vertical upside count of 8900 may be established. But notice the 8900 count is never activated because the price did not exceed the high of the counting column. For bulls, that is a worrying sign. Here is an upside count which has not been activated, providing some early evidence of bearishness.

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Chart 5-13: 2nd chart analysing the 50 x 3 of the FTSE 100 Index

The price turns, giving a double-bottom sell signal which may be ignored as no trend line has been broken, but then, after bouncing on trend line 2, gives another sell signal while breaking trend line 2, which must now be taken. It finds support on the main bullish support line 1 at point E. A mini-top has also been made and a downside count of 5550 is established and activated. So instead of an upside count being activated, a downside count has been. The date is February 2000. It is the first time that the bullish support line has been tested since 1992. Once again, the price thrusts away from the main bullish support line reinforcing its importance. Once again, a new upside count (not shown) may be established. Once again, the count is not activated.

It is just as well to stop and weigh up the evidence. The price has bounced off the long-term bullish support line, confirming the bull trend is still in place. Two thrusts have produced good vertical counts, but neither has been activated. There is an active downside count of 5550 running against the 7400 upside count. The columns of XS are no longer dominating; they are beginning to balance out with the columns of Os. Clearly, the price is trading sideways within a range which indicates distribution when the prior trend is up. The bull market is still intact, but, where there was no bearish evidence before, there is some now.

The price rises away from the bullish support line with a double-top buy signal. Once again, you would take out long positions. It makes another mini-top at F, giving another sell signal as

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well as another downside vertical count of 5800. As a medium-term trader, you have seen two long trades go wrong, which is a worrying sign of a change in the characteristic of the chart.

The price approaches the main bullish support line again and, without pausing, breaks through. There is no double-bottom sell signal on the break, so you would do nothing until the next one, which occurs a few columns later. Even with all the evidence switching from bullish to bearish, it is still possible not to be completely bearish. What may be forming is a large continuation pattern with strong support at the 6000 level – shown by the blue horizontal line – before the ascent to the 7400 target.

It is just as well to make a comment about the 7400 count. There will always be one upside count that will not be achieved during a bull trend, just as there will be at least one downside count in a downtrend that will not be achieved. That is not to say that you know this is one now, but it is always worth remembering it. As a count begins to look less likely – which is the case with the 7400 count now – so you must begin to assume it will be the one count that will not be achieved.

Notice how the price hugs the underneath of the bullish support line 1 as it rises to point H. Although there are double-top buy signals during this phase, you would not take them as the price is below the bullish support line. Notice that as the price rises underneath the bullish support line, it also forms a small bullish continuation triangle, where the move into the triangle equals the move out to point H, where it makes another mini-top. Another downside count of 5 1 00 may be established and activated. Notice how the columns of Os are beginning to dominate, indicating increasing bear trend action.

With bullish support line 1 being conclusively broken, new bearish resistance line 6 may be drawn from point H. The evidence is swinging more towards a bear trend now. Remember, however, it is not all to do with trend lines and counts. You must always look for patterns and one ofthe most powerful patterns in Point and Figure analysis exists in its inverted form. The circled area shows a bearish or inverted catapult. Anyone still holding longs must certainly close everything once the price makes its second double-bottom breakout of the inverted catapult. Because this occurs below the main downtrend line, you may even start opening short positions. It is now the strongest piece of evidence in favour of the bearish side.

Finally, if you still had any bullishness left at the beginning of March 200 1 , the price broke down below the 6000 level, below the blue support line. Look at the chart now. Can you see any evidence that the bull trend still exists? Weigh up the evidence for yourself, and if you can still see a bull trend, read on . . . . . . . . .

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Flipping charts

Now is a good time to introduce a technique every Technical Analyst should use. The technique is: when in doubt, flip your charts upside down. Ifyou don’t have software that will do it, simply print out the chart, tum it over vertically so the chart is turned upside down and the unprinted side of the paper is facing you. Hold it up to the light and look at the chart through the paper. You will be amazed at what you see. Flipping your chart removes any in­ built bias that you have. If you are an eternal bull, it removes your bullish nature; if you always see the bear side, it removes your bearish nature. Although you are consciously aware that the chart is upside down, your sub-conscious does not and forces you to analyse it as if it is what you are seeing.

Chart 5 – 1 4 is the FTSE 1 00 Index flipped upside down. Notice that the advantage of software doing it is that it will change round the columns of XS and Os as well. Notice the main downtrend line was broken halfway through the ‘basing’ pattern. Notice also the break above the blue resistance line. But, most of all, notice the very bullish catapult buy signal, circled. What you are looking at is a very bullish recovery out of a long downtrend. Would you buy it? Then remember that what you are looking at is a very bullish chart, which is actually upside down and that can only mean one thing. What you are really looking at is a very bearish chart when it is turned the right way up!

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Chart 5-14: Flipped 50 x 3 chart of the FTSE 1 00 Index

Having decided that your flipped Chart 5-14 looks bullish, you have to see Chart 5-13 as bearish.

The analysis (the right way up) continues with Chart 5-15. The price falls, uninterrupted by any 1 50 point rally, to point 1. In fact, it took nearly a month to do so, giving you more than enough time to close all longs. In the process, it achieved both the 5100 and 5550 downside counts. This is an important point. It is the first time since 1984 that a downside count on the 50 x 3 chart has been achieved. Remember, the achievement of downside counts is more evidence ofbear trend action. Not only is the price below the bearish resistance line, but also downside counts are being achieved. It now makes it more likely that the final 7400 upside count will not be achieved, but that can only be confirmed when the price breaks below 4650, the level at which the count was taken.

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A new vertical downside count may now be established from the breakaway column, yielding a downside target of 3450. The count is not yet active. A small bottom is made at point I, allowing an upside vertical count of 6400 to be established and activated. The risk-reward ratio for the 6400 count is only 2.2, which is on the low side and may make you suspicious. The double-top buy generated should be used to close any short positions, but under no circumstances should any long positions be taken out as you are below the bearish resistance line. A new tentative 45° uptrend line 7 can be drawn from point I . The line provides you with support for the small uptrend, which, ifbroken, re-confirms the downtrend.

The price rises from this bottom up to the blue resistance line. The blue resistance line at the 6000 level was initially the support line for the top pattern. Remember how support, once broken, becomes resistance. The price makes four attempts at breaking above this blue resistance level. The last attempt was met by the additional resistance from downtrend line 6. The resistance is now very strong. A break above the resistance line would confirm the resumption of the uptrend. Bulls would have been praying for this to happen here.

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The price is poised either to give a very strong buy signal if it breaks above the quadruple­ top, or to be resisted and continue the downtrend. To break above, all it needs to do is rise by 50 points. The conflict is eventually resolved when internal uptrend line 7 is broken with a double-bottom sell signal, so further short positions may be taken out on the break.

There are a number of things to notice in relation to counts. A new vertical downside count of 4000 is activated. The previous upside count of 6400 is cancelled because the price falls below point I and the downside count of 5 1 00 from the top is achieved. All these add up to confirmation of the bear trend. The additional double-bottom sell at point J reasserts the downtrend and allows additional short positions to be taken out. During this down move another very significant thing occurs; the last active upside count of the bull trend, 7400, is finally cancelled because the price has fallen below the low of the count column. There is nothing bullish left in the chart.

The price makes a bottom at point K and rallies sharply, allowing another vertical upside count of 6700 to be established and activated by the next X column. The double-top buy signal should once again be used to close any shorts. You cannot take long positions below the main bearish resistance line. New tentative 45° uptrend line 8 may be drawn from point K. The price runs into resistance from the downtrend line at point L. A double-top buy signal and a break of the downtrend would signal a new uptrend but it doesn’t occur. Instead, the price turns down again and breaks uptrend line 8 and cancels the upside count of 6700, because it falls below the point at which the 6700 count was taken. Another downside count using the break away column may be established, giving 2600 as the target. It is important to pause and think about this target. There are already two active downside counts, of 4000 and 3450. Only once these counts have been achieved can you seriously consider the lower count of 2600.

Count 4000 is achieved as the price falls further and the bear trend strengthens. Notice the long columns of Os and short columns of Xs confirm bear trend action and move the action well away from the main downtrend line. Then what happens is that the price starts to trend sideways. The column lengths start equalling one another. Sideways movement after a downtrend shows accumulation. It may, however, just be profit taking before a continuation of the downtrend, so no action should be taken. The price is still well below the bearish resistance line.

A mini-top is made at point M, allowing another downside vertical target of 3350 to be established. Notice that there are two downside counts targeting 3350 and 3450, indicating that this is what the price is aiming for. Both counts are achieved at point N, leaving one remaining downside count of 2600 outstanding. Remember what was said earlier: there will always be one count at the end of a trend which is not achieved. There is no evidence to suggest that 2600 will be that count at this stage, however.

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From point N, the price has a strong rally and a new vertical upside count of 4950 can be established, which is then activated. With the previous history of these vertical upside counts not being achieved, there is little hope that 4950 will be achieved, especially as the price is below the main bearish resistance line and there is a 2600 downside count waiting to be achieved. The price continues to rise, however, and breaks the bearish resistance line at point o which is a significant break but not a valid Point and Figure break. It is, therefore, not a signal to go long, although all shorts should now be closed.

Look left on the chart and note that the price has also broken horizontal resistance offered by the blue resistance line. It then corrects back below the resistance and stops above the downtrend line, before rising again. The pattern is beginning to look interesting. It is a good

time to weigh up the evidence.

The bear trend line has been broken.

The price has been pushed back down to the break but there is enough demand to push it back up again and is sitting on a possible double-top buy.

The price has broken through horizontal resistance, been forced back and then broken above it again.

All downside counts, except 2600, have been achieved.

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The conclusion must be that the evidence is in favour of a new bull trend and all that is required to confirm this, is a double-top buy signal. The price does just that. It gives a double­ top buy and breaks above another important resistance line shown in blue. See Chart 5-16 opposite.

The price has spent some time moving sideways in a range after a long downtrend, indicating accumulation.

There is an upside target of 4950 from the bottom where downside targets were achieved.

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Chart 5-16: 4th chart analysing the 50 x 3 of the FTSE 100 Index

But even with this evidence, you may still feel bearish. You may not be able to see a bottom. You may see it as a pause within a downtrend. If you have a bearish bias, then flipping the chart is the only way to resolve your dilemma. It removes your sub-conscious bias.

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Chart 5-17 is the flipped chart. Does it look like it is making a top? If so, then you believe that the price is actually making a bottom. If, however, you think the flipped chart is simply a continuation pattern that will go higher, then you believe that the actual price will go lower. Flipping the chart can really make it so much clearer.

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Chart 5-17: Flipped version of chart 5-16

Chart 5-18 shows the chart the right way up again. Now that the main downtrend has been broken, new main 45° uptrend bullish support line 9 may be drawn from the low at point N. This is your new bull trend, remembering that there is still a downside count hanging over you, but remembering as well that there will always be one downside count that will not be achieved. At this stage, you don’t really know, but there is no doubt that, for the time being, the trend is up again.

In addition to the main bullish support line, internal 45° trend lines 10 and 11 should be drawn from reaction points to give additional support levels. Notice how trend line 11 provided support to the price at point P.

Notice the structure of the new trend. The columns of Xs are longer than the columns of Os. Columns ofXs are breaking out ofdouble-tops, giving repeat buy signals, but Os are not even reaching the levels of the previous Os, until at point P there is a double-bottom sell signal. It is customary to ignore the first double-bottom sell in any new bull trend as this tends to be

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caused by profit taking by early adopters of the trend. It is a shakeout of weak holders. However, if you feel comfortable taking the sell, then by all means close any longs at this stage and wait for the next double-top buy signal. The fact that, after the double-bottom sell, the price found support on a trend line and turned back up again confirming the bullish nature of the trend. Then a triple-top buy signal occurs, reasserting the uptrend. Remember a triple­ top means that the buyers tried three times to break the sellers’ resistance and eventually managed to do so. It is just as well to note that the triple-top pattern took a year to form. Although it takes no part in the analysis, that is a year of frustration for bulls and bears. After breaking the triple-top, the price then went on uninterrupted to achieve and exceed the 4950 target set nearly two years previously. This target was established at a time when few would have believed it possible.

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Chart 5-18: 5th chart analysing the 50 x 3 of the FTSE 100 Index

This is the first upside count to be achieved since the 6100 count in 1998. This confirms the new bull trend and lessens the likelihood that the downside target of 2600 will be achieved, although the 2600 count is still valid. Notice that the 4950 target also coincided with horizontal resistance from previous congestion, showing that it is vital to ‘look left’ when doing your analysis. Additional resistance lines drawn by looking left are also shown in Chart 5-18. You must always be aware that these exist, as it is likely they will provide some resistance that may also coincide with other counts in the future.

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Taking a shorter-term view

There comes a time when the chart you are looking at can give no more information until further patterns develop. That is the case with the 50 x 3 chart of the FTSE 1 00 Index. The last long column ofXs from the mini-bottom will eventually be used to obtain the next upside target, but that can only be done after the price corrects by 1 50 points or more to generate a column ofOs and fix the length ofthe column ofXs. It is at this stage that you need to reduce the box size to extract more information from the chart by taking a shorter-term view. In fact, a good Point and Figure analyst should have a different box size chart available all the time anyway, because it gives a different time horizon.

Chart 5 – 1 9 shows the 25 x 3 chart of the FTSE 1 00 Index. Work your way through it from the left with the knowledge to have gained from the 50 x 3 chart, drawing trend lines first, then counts. Notice the fulcrum top pattern, marked A, which could have been a continuation of a new uptrend, but turned out to be a top instead. At the time, the pattern looked bullish and short-term long positions could be taken out on the double and triple-top buy signals. You would remain long while the price remained above short-term 45° trend line 1 and above the blue support line. However, longs would be liquidated on the break of the trend line at point B and shorts taken out on the break of the support line at point C . Remember that all the time this was happening, the price was still below the bearish resistance line in the 50 x 3 chart. In the 25 x 3 chart, the trend lines are shorter-term.

New 45° bearish resistance line 2 may now be drawn, confirming the continuation of the downtrend. The fulcrum top allows two counts to be extracted: a horizontal count of 3250 and a vertical count from the breakout column of 3450. Notice how similar these are. Notice too, that the 3450 count matches the 3450 count taken from a completely different place on the 50 x 3 chart. This gives considerable weight to the target area, as so many counts are homing in on it.

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Chart 5-1 9: Analysing the 25 x 3 of the FTSE 1 00 I ndex

A mini-top allows internal downtrend line 3 to be drawn, as well as a new intermediate downside target of 3850 to be established. Notice how that target was achieved within a few columns, confirming the bearish nature. The price rises and bounces off trend line 3 at point D, allowing another downside target of 3225 to be established from the mini-top. There is now overwhelming evidence that the target area is around 3200 to 3400. Targets are not exact; they give you a rough idea of how far the price will go.

The triple-top buy at point E indicates that shorts should be closed. Remember the rules suggested when trend lines were discussed: because the triple-top buy occurs below downtrend lines, long positions should not be taken out. The price breaks through trend line 3 at point F. Depending on your time horizon, you may take long positions on this break, noting that the price is still below the main downtrend line 2. If you are in any doubt about what to do, you should look at a more sensitive chart. The price does not follow-through; instead, it creates yet another mini-top, yielding a downside count of 3350. If the message hasn’t got through yet, it should now, because another count comes within the 3200 to 3400

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target area. It would now be wise to ignore any signals to go long until these downside targets have been achieved or a main downtrend line has been broken.

Another mini-top yields a target of 2500. Note that this is only 1 00 points from the 2600 target hanging over the 50 x 3 chart, which was taken from a completely different part of the chart.

Eventually, the predicted target area of 3200 to 3400 is reached and the sharp rise from it – the longest column of Xs on the chart – breaks trend line 4 and the main downtrend line 2 a few columns later, allowing new bullish support line 5 to be drawn. All short positions should now be closed and long positions taken out, because there is a sequence of double-top buys before and after the break ofdowntrend line 2. At the same time, a new vertical count of4950 can be established. Internal trend line 6 may be drawn at the reaction point as well. Notice how it provided support at point K. Notice, too, that the price is now above the point at which the 2500 downside count was taken – shown by the red horizontal line – thus cancelling the count. On the 25 x 3, there are no unfulfilled downside counts – a significant point. Notice the mini-top at point G, allowed the establishment of a downside count (not shown), which was never activated. All these occurrences contribute to a bullish viewpoint.

As the trend matures, new double-top buys are generated, allowing new long positions to be taken out. Eventually, a double-bottom sell is generated at point H, but, because this is the first of the new bull trend, it can be ignored unless it matures and breaks trend line 6. What does occur is a mini-bottom allowing an intermediate upside vertical count of 4850 to be established and activated. The uptrend continues and a second double-bottom sell occurs at point 1. It is a minor sell because it is above an internal trend line; however short-term traders may wish to take profits and wait to see what happens. What does happen is another double­ top buy at point J, which does not follow-through and which yields a loss when closed on stop at the double-bottom sell. A mini-top is created, yielding a downside target of 4050.

It is just as well to note here that whereas many believe you should take every double-top buy, and every double-bottom sell signal, it is not the case. A certain amount of subjectivity is required by considering two things. Always look left to see if there is additional support or resistance, which makes the double signal weak, and always consider the position of the signal in relation to the 45° trend lines.

The price falls from the mini-top at point J to support on trend line 6 at point K, where it makes a mini-bottom yielding a new upside target of 5450. At the same time, the downside count of4050 is negated, adding more weight to the bullish evidence.

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So, that is the position at the time of writing. The first vertical count off the bottom has been achieved, with the next target at 5450. It is not possible to say whether that target will be achieved, but ifthe price does get into that area, it will also face resistance from the horizontal resistance line at 5 3 5 0 , shown on the 50 x 3 Chart 5 – 1 8 . At the present time, the current trend is up. New internal trend lines 7 and 8 will give you indications of any deterioration in that trend. The price has reversed by 4 boxes, or 100 points, which is to be expected after such a steep uptrend.

The advantage of Point and Figure, however, is that you can continue to ‘drill down’, exposing more information by reducing the box size. Remember, you are still looking at the same set of daily data.

Chart 5-20 is now a 10 x 3 of the FTSE 100 Index, exposing more information about the recent uptrend.

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Chart 5-20: Analysing the 1 0 x 3 of the FTSE 1 00 I ndex

Notice how accurately the 4850 count was achieved and how the price paused afterwards, indicating profit taking. The next target from the 10 x 3 chart is 5 120. Internal 45° trend lines 2 and 3 may be drawn to show additional support in the uptrend. Notice the bearish pattern reversed – or flag – prior to the bottom at point 2. The first double-bottom sell within this pattern would be ignored because it is the first in the trend; the second would, however, be

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taken. The double-top buy signal emerging from bearish pattern reversed (flag) is an important signal and should be taken.

It is likely that the double-bottom signal at point 3 would be ignored and instead notice taken of trend line 2. The final triple-bottom sell signal at point A is a signal to stop buying and take short-term profits. If the bull trend is in place, then the downside target of 4790 will not be achieved. To achieve it, both internal lines 2 and 3 will have to be broken.

If you are a medium-term bull waiting to take out long positions, then you will be watching the shorter-term Point and Figure chart, perhaps this 10 x 3 chart, for the next buy signal. At the moment, it is telling you to hold off. Short-term charts like this can really help longer­ term investors with their timing.

Changing time-frames

The analysis does not have to stop here. As stated earlier, you may continue to shorten your time horizon by reducing the box size on your daily charts, but there will come a time when switching to intra-day data exposes even more information.

Chart 5-21 is a 5 x 3 Point and Figure chart using hourly data, that is the close price at the end of every hour, thereby using 8 prices per day to construct the chart. This is a short-term chart, but you treat it just like any other chart. The analysis is the same, no matter what data the chart uses. The bull and bear trends are simply mini bull and bear trends within larger bull and bear trends.

The chart shows the section outlined in Chart 5-20 above but much more clearly. Notice 45° trend line 1 being broken by the breakout out column from the W pattern, indicating a new mini bull trend and allowing 45° trend line 2 to be drawn. The W pattern has clear entry and exit walls, so a horizontal count may be established, yielding a target of4710. In addition, two vertical counts may be taken from the two bottoms, yielding 4680 and 4520.

Internal 45° trend line 3 may be drawn as well. The price rises and forms a triple-top pattern where there is a double-bottom sell, which, being the first in the new trend, can be ignored.

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Chart 5-21: 1st chart analysing the 5 x 3 hourly chart ofthe FTSE 100 Index

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Chart 5-22 shows the price continuing to rise and to achieve and exceed the 4520 target. Another internal trend line 4 may be drawn from the mini-bottom and a new vertical count taken on the first move off the mini-bottom, yielding 4765. Notice the bullish catapult at point A.

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Chart 5-22: 2nd chart analysing the 5 x 3 hourly chart of the FTSE 100 Index

The price continues to rise and thrusts a new column of XS above the price action, followed by an adjacent column of Os. This could be a high pole in the making. Either you close longs during the 50% retracement by the column of Os, or you wait for a double-bottom sell signal to occur.

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Chart 5-23 shows the chart to the end of the data at the time of writing. You should try to analyse it sequentially, without looking right. The first thing to notice is that the double­ bottom sell does occur and the high pole completes. The price falls and sets up a low pole that stops short of trend line 4. The occurrence of a high pole followed immediately by a low pole is bullish, and the first double-top buy signal after the low pole must be taken. Another vertical count of 4720 may be taken off the low pole. There are now three counts targeting the 4680 to 4720 area. When this happens, you must take note that the area is significant.

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Chart 5-23: 3rd chart analysing the 5 x 3 hourly chart of the FTSE 1 00 Index

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A small top forms in the 4720 target area at point 5. There is a triple-bottom sell signal, but looking left shows there is still support one row below, so it is advisable to ignore the triple­ bottom. However, the price falls through the second support line and the top pattern is complete, giving a short-term sell signal, albeit above the internal bullish trend lines. If a target is hit and a sell signal occurs, it is advisable for a short-term trader to take profits and wait for the next clear entry signal. Remember, once you have decided to act, you must wait for a standard Point and Figure signal before doing so.

45° downtrend line 5 may now be drawn from the top. The price falls and breaks internal trend line 4, forming a low pole at point B, which yields a new upside count of4855. The count is activated and breaks up through downtrend line 5, signalling you to go long. At this point, new internal 45° uptrend line 6 may be drawn.

In the area marked C, the price trends sideways, indicating distribution. There are no clear­ cut signals. The price continues sideways and finds support at point D on internal 45° line 6. The thrust away from that support is bullish and confirms the strength of trend line 6. Two counts can be established from the pattern marked C: a horizontal count of 5050 and a vertical count of 5060. Notice how close these two targets are. Often a vertical and horizontal target from the same pattern will coincide, meaning the pattern is square; the length of the thrust column off the bottom is the same as the number of columns in the pattern.

Once again, the price comes close to trend line 6 at point E before rising sharply again and generating another vertical count of 5030. You now have three counts within 30 points of each other, indicating that the area 5030 to 5060 is an important target area and any sign of a top there, such as a double-bottom sell, should be taken as a signal to close long positions.

When there is a vertical rise like this, additional internal 45° lines become important for support and are shown as lines 7 and 8. The position at the end ofthe data is that the target area has been reached. Some short-term traders would close longs on that basis alone, others will wait for a clear sell signal that would be a break of trend line 8 . Trend line 8 does indeed break and the price finds support on the blue support line F. A break below the support points to a possible target of 4850.

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The catapult does in fact break out, allowing another vertical count of 5220 to be established. The previous vertical target of 5030 is reached and exceeded, confirming the bull trend. New internal 45° trend line 3 may be drawn from the low of the catapult at point E. This is now your support level.

The price continues to be bullish up to point F, when it turns down, breaking a small internal trend line 4, at the same time giving a double-bottom sell signal. It then breaks internal trend line 3. New 45° downtrend line 5 may be drawn from the top. The price falls to point G, finding support from the line running below the catapult pattern to the left. At the same time, the 5220 vertical count, set just above this level, is cancelled and a new downside count of 4775 is established.

The price rises to break the small downtrend line 5. The break is followed by a double-top buy signal. Ifyou take this signal you must be aware ofthe resistance from the horizontal line from point F. The rally runs out of steam and the price turns down again, allowing new 45° downtrend line 6 to be drawn from point H and a new vertical downside count of 48 1 0 to be established. Notice how the lengths of the columns of XS and Os are changing to a more bearish nature. The fall from point H breaks two 45° uptrend lines, including the main one from the bottom. It then rises up underneath the uptrend line 1 to encounter resistance from the small bearish resistance line 6 before forming a top, yielding a new downside target of 4780. This is the position at the time of writing.

That is the end ofthe 3-box analysis. Some ofthe main points will be summarised at the end of this chapter. What you must remember when ‘drilling down’, is that although you are looking at shorter and shorter-term charts, particularly when you switch to intra-day data, you must not forget your own personal time horizon. If you are a medium-term trader and are looking at a tick or other short-term chart, you are doing so to give yourselfmore information about your medium-term trades, not to make you trade short-term. Medium-term traders can, and should, use tick or at least 1 minute charts to help to fine-tune their timing.

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Analysis using 1 -box reversal charts

The analysis of I-box reversal charts is different from 3-box charts in a number of aspects. The first is that 45° trend lines have little validity, so most trend lines are drawn subjectively. The second is that, as you have read earlier, the double-top and bottom signals in the 3-box sense have no validity. You are looking instead for semi-catapults as continuation patterns, and catapults from fulcrums as reversal patterns. Vertical counts are not possible either, and horizontal counts tend to give a shorter-term view. So why use I -box charts at all?

I -box charts really tell you much more about what is going on. You will, however, have to practise with I -box charts to familiarise yourself with them. I -box charts are not a substitute for 3-box charts – they complement them. Early adopters ofthe Point and Figure method used I-box charts as well as 3-box charts. The 3-box charts gave them the longer-term view, but that does not mean you cannot use I-box charts for medium- to long-term analysis. Once again, try to follow the process sequentially. If necessary, cover up the right-hand side of the chart.

Chart 5-25 shows a log scale 2% x I chart of the NASDAQ Composite Index. Once again, it is not the choice of the instrument that is important; any instrument could have been chosen, as the analysis is the same. A log scale chart is chosen to show you that the analysis of log scale charts is the same as arithmetic charts. It is customary with medium-term I -box charts to start with a box size larger than you would have used on a 3-box chart, hence the 2% box size. This means every box change with, or against, the trend is 2%.

The first thing you will notice is that the chart is constructed using the traditional Point method ofXs only rather than Xs and Os. Although this was mentioned earlier, it has not been used until now, because knowing whether a box had an X or an 0 was important for your understanding of construction and pattern analysis. The preferred way to analyse a I -box reversal chart, is however, with Xs only because it is not important to know whether a box has an 0 or an X. It may not seem to be the case now, but the removal ofthe Os does make the chart easier to read. There is also no reason to identify them with colour, which is why black Xs have been used. Drawing I -box charts on a squared grid helps analysis too. Finally, for convention and ease of articulation, all trend lines are drawn in red, all horizontal resistance lines indicating breakouts or potential breakouts from catapults and semi-catapults are drawn in blue and all horizontal support lines are drawn in red. Signals to buy and sell come from ordinary breaks oftrend lines as well as breaks from catapults and semi-catapults.

The chart starts with the November 1990 low. You must analyse the chart from the left sequentially, referring to the text as you do, otherwise you will not understand why certain lines have been drawn.

During the rise from the low, notice the one-step-back as well as the semi-catapult continuation buy signal marked A. Notice the upward sloping bottom in the semi-catapult, showing bullish tendency. Once the semi-catapult completes by breaking out, you may draw

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your first trend line, 1 , touching the base of the semi-catapult. The price continues to rise to point E, where it falls back to trend line 1, and breaks it. Uptrend lines are broken because the speed of the price rise has slowed and the price is moving sideways rather than up. In 1 – box terms, it is a signal to close longs. What happens next is what helps you decide whether to open shorts. The price continues down, making new lows, but only a break below red support line B would complete a small fulcrum top and signal an opportunity to open shorts. However, notice support line B 1 below. The presence of this indicates that you should be cautious when opening shorts. The price breaks B but not B 1 ; instead, it continues to trade sideways. Notice the short columns containing 2 boxes. This is distribution and profit taking place. Once that has completed, only the presence of strong new buyers can make it rise. Look to see where most of the price action is taking place as this can give you a clue as to the next move out of the pattern. In this case, the pivot or balancing row of the pattern, where the most Xs occur, is near the low. This is the level where you would take the horizontal count. Remember that all I -box reversal counts can be up, as well as down counts. You would normally establish both ifyou are unsure ofthe direction at the time. From now on, however, only the activated one will be drawn to avoid cluttering the chart.

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Chart 5-25: 1st chart analysing the 2% x 1 of the NASDAQ Composite Index

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There are three possible catapult points out of the fulcrum pattern to the upside, marked with three blue resistance lines, C, D and E. The first buy signal comes from the break of C. It is a weak signal because you will be aware of line D as well, but short-term traders can start taking long positions on breaks of these lines, with stops below the pivot row of the pattern. Once the price breaks C, the horizontal count of 694 becomes active and new uptrend line 2 may be drawn to the right side low of the pattern. The price reaches the 694 target and starts to trade sideways again. Once again, this is distribution caused by profit taking. It finds support on previous resistance line E, as is often the case as the price ‘climbs the steps’, and on trend line 2 which is a bullish sign. The next semi-catapult point is resistance line F, with a horizontal target taken at the row with the most Xs of 80 1 .

The 801 target is reached and again there is some sideways congestion, eventually breaking trend line 2. This is a sell signal to close longs. What then forms is a small inverted fulcrum that completes with the break below the red line marked G. This is a signal to open shorts, because not only has the main uptrend line 2 been broken, but also there has been a catapult sell signal. However, because the downside target is 694, only 2 boxes, or 4%, below where you open the short, you may decide not to take the trade. Furthermore, your stop would have to be either one row above the count row or above the pattern high, resistance line I, which is 6 boxes, or 12%, above your open level, making the risk-reward ratio most unfavourable. Whatever you decide, the price is in a downtrend, shown by the new downtrend line.

The price continues down and makes a low, but then immediately runs back up again breaking the downtrend line, and encounters resistance from horizontal line H. The position is now neutral. There are sellers at line H, but there is no level that can be called the buying level at this stage. Notice, however, that when the price falls again, it does not get down to the previous lows. This means buyers have moved up their buying level and is typical bullish fulcrum action; the right side of the pattern is upward sloping. The catapult point for the fulcrum is line I; however, a break of line H may be used to open early long positions.

The price breaks both line I and line H, enabling you to establish a horizontal count of 998 across the row with the most Xs. Notice that this is not actually the longest row in the pattern. At the same time, new uptrend line 4 may be drawn from the low, touching the right-hand side of the bullish fulcrum. The price then runs uninterrupted up to the target of 998. This means that at no time did it retrace by 2% or more. Notice that, as the target is reached, there is sideways activity as profits are taken and distribution takes place. A small semi-catapult at J then takes the price higher. In fact, the target out of the semi-catapult (not shown) takes the price to point K. After a move of this magnitude, profit taking is to be expected and so the price trades sideways again as stock is passed from old holders to new holders. Once again, you must look for clues as to where the weakness is in the pattern and where the pivot or pattern anchor point is. The pattern is only four boxes high, locked between support line L and resistance line K. The pivot ofthe pattern switches between rows 2 and 3, giving no clues at all, but then the price breaks through the resistance at line K, allowing another upside count of 1282 to be established.

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Look left on the chart. It is very bullish. There have been three uptrends and only two small downtrends that lasted only a few columns.

The analysis continues with Chart 5-26. The price pulls back after the break and hits the 1282 target in a one column thrust. It then retraces the rise without giving any signal. It trades sideways at the lower level, eventually finding support on uptrend line 4, from which it rises again. Resistance line M is the semi-catapult point for the next move. You are still long waiting for new entry points. Because there have been no breaks of any uptrend, there have been no sell signals. The price breaks resistance line M and pulls back below it again, finding further support on uptrend line 4. Another semi-catapult line may be drawn at point N. When the price breaks this, a new horizontal count may be established from the pattern beneath it across the row with the most Xs. This yields a target of 1 572. Once again, the target is hit and exceeded by a few boxes, confirming the strength of the uptrend. Further sideways action sees the price set up for another semi-catapult at resistance line O.

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Chart 5-26: 2nd chart analysing the 2% x 1 of the NASDAQ Composite Index

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When it does break above line 0, another horizontal count may be established, yielding a target of 1981. Again, the target is exceeded. The price then forms an inverted fulcrum, breaking down through catapult point P as well as breaking uptrend line 4, a well-established and last remaining uptrend line at the time. All longs should, therefore, be closed and shorts taken out. At the same time a new downtrend line 5 may be drawn. The price falls by 10 boxes from the catapult line, then rallies with a catapult and breaks the downtrend line 5. Shorts must be closed – probably for a loss. Longs will only b e taken out on the break o f line Q. New uptrend line 6 may now be drawn from the bottom to the recent low.

After breaking above line Q, the price continues to rise in steps, forming a number of small semi-catapults shown by the blue unlabelled resistance lines. Notice that a new angle trend is emerging, allowing you to place another trend line, 7, on your chart.

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The action carries on in Chart 5-27. After breaking through semi-catapult R, the price runs up strongly making another semi-catapult at S. The base of this catapult allows a sharper uptrend line 8 to be drawn, reflecting a change in trend angle. Although horizontal counts are not shown, they have all been exceeded, confirming very strong bull trend action. The price hits a high at point T, but then makes a small inverted fulcrum with the catapult point at U, coinciding with a break oftrend line 8. Longs should be closed but shorts should not be taken out because the price is still subject to the main uptrend line 6. A downside target of 4289 may, however, be established from the inverted fulcrum which takes the price down to a continuation semi-catapult at point V. A tentative sharp downtrend line, 9, may be drawn, touching the right side of the semi-catapult once it completes.

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Chart 5-27: 3rd chart analysing the 2% x 1 of the NASDAQ Composite Index

A bullish fulcrum with a catapult point at W forms beneath the downtrend line 9. Although names are not important, it is called a recoil fulcrum, which tends to occur after a steep fall in price. It is a strong pattern and once the breakout occurs it should not be ignored, especially as the downtrend line is broken at the same time. When a fulcrum has a clear pattern ofrising bottoms on the exit, new uptrend line 10 must be drawn. In this case, the recoil fulcrum fails to prove any strength and the price falls below trend line 10 stopping you out, but you can

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chart? If you can, it means you have a bullish bias – the most common affliction that traders suffer from in a long bull run.

You already know the cure, it was discussed on page 29. When in doubt, flip your chart upside down. Chart 5-29 shows the same chart turned upside down. Does it look bullish or bearish to you? Can you see the break of the downtrend as well as the classic fulcrum bottom formation and the break above the catapult point at the blue line? There is no doubt you would see this as the beginning of a new uptrend and would want to buy the index. If that is the case, then you are seeing an important top being made on the normal chart. It cannot be stressed enough. Flipping your charts upside down exposes you to a whole new dimension of analysis.

Chart 5-29: NASDAQ Composite Index from 1 990 to 2000 flipped upside down

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The analysis continues with Chart 5-30. The break below the catapult point of the fulcrum is a signal to open short positions because this occurred below the main uptrend line. New downtrend line 1 1 may now be drawn touching the right-hand side of the inverse fulcrum. At the same time, a horizontal downside count of 2049 may be established from the fulcrum across the row with the most Xs, which also happens to be the row at the top of the breakout column. Notice how the price pulls back up again after the break in a small potential bullish recoil fulcrum pattern marked (a), but does not break above its catapult point to activate it. Instead, it continues lower, forming a number of inverted semi-catapults reinforcing the downtrend. A small bullish fulcrum at point (b) signals you to close shorts and wait for the next indication. Remember, you cannot open longs below the downtrend line 1 1 .

The price turns down again signalling another opportunity to open shorts when the semi­ catapult marked (c) is activated. Although not shown, horizontal downside counts from each semi-catapult are exceeded. The price then forms another small bullish fulcrum at (d), signalling the closure of shorts again. This does not lead anywhere either and the price continues down, forming a larger inverted fulcrum/semi-catapult at (e) which yields a horizontal downside target of 2053. The top of this pattern allows new internal downtrend lines 12 and 13 to be drawn. The price continues lower and eventually forms another small bullish fulcrum below line 1 3 . Shorts must again be closed, but no longs must be opened. The price breaks above trend line 12 at point (t), but longs should still not be opened because you are still below the main bearish downtrend line 1 1 .

A large inverted fulcrum forms with its catapult point at (g), which, when broken, is a signal to open shorts again. A horizontal downside target of 1 526 may be established from the row at the top of the breakout column and new downtrend line 14 may be drawn, touching the right-hand side of the fulcrum.

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Chart 5-30: 4th chart analysing the 2% x 1 of the NASDAQ Composite Index

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The analysis continues with Chart 5-31. The 1526 target is achieved and the price rallies strongly, breaking through internal trend line 14, but meets resistance at the blue horizontal line from where it forms another inverted fulcrum with catapult point at (h). Trend line 15, drawn from the same origin as trend line 14, becomes the new internal downtrend line. Notice, however, that although the price is falling and rallying, the bearish pattern of lower highs and lower lows is maintained. Notice also that there is no accumulation taking place. This occurs when, after a down move, the price trades sideways. That is not yet happening. The only sideways trading that is occurring is after the sharp uptrends, which indicates distribution.

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Chart 5-31 : 5th chart analysing the 2% x 1 of the NASDAQ Composite Index

Notice that something starts to change in the chart. Downtrend line 15 is not broken by a sharp rally; instead it is broken after some considerable sideways congestion which begins to form a bullish fulcrum with a catapult point at (i). If you can’t see it, flip your chart upside down again.

A break above catapult point (i) completing the fulcrum would result in all shorts being closed. The upside target taken at the bottom of the breakout column yields a count of 2245, making the risk-reward ratio favourable for longs even though the price is still below the main downtrend. As the price rises out ofthe fulcrum, notice that, in textbook fashion, there is a series of semi-catapults indicated by the blue horizontal resistance lines, eventually breaking the main downtrend line 1 1 from the top. At this stage a new uptrend line 1 6 may be drawn touching the rising bottom on the right side of the fulcrum bottom. As the price

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approaches the target of 2245, it begins to trade sideways, indicating profit taking and distribution. It corrects back and touches the new uptrend line, reinforcing it as the new main trend.

A break below trend line 1 6 would put the chart back into a bear trend.

Taking a shorter-term view

As with 3-box charts, you may change your time horizon by simply changing the box size of the chart. Chart 5-32 shows the result of halving the box size to 1%. The section shown is from the 2002 bottom to the present. Notice how more trends are exposed, making it easier for the shorter-term trader to find short-term opportunities. Notice how a potential inverted fulcrum with potential catapult at A, not visible on the 2% chart, is exposed on the I % chart.

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Chart 5-32: Analysing the 1% x 1 of the NASDAQ Composite Index

I -box charts actually thrive on intra-day, especially tick or I minute data, which is where they originally came from. Once you move to intra-day data, however, you should use arithmetic points box sizes rather than log. The reason is that you are no longer taking a general view and at this level each round number can be psychologically important for market participants. You are interested in the actual prices recorded because these are the prices that are being

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dealt by the participants and it is their behaviour you wish to assess. Although it IS recommended for all intra-day time-frames, it is essential for tick charts.

Chart 5-33 is a 10 x I Point chart using hourly data, showing the section ofthe chart from the August 2004 low. Notice how trends become much clearer: fulcrums and semi-catapults become more visible for the short-term trader. The potential inverted fulcrum that was barely visible in Chart 5-32 is now clear and well formed in the hourly Chart 5-33.

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Chart 5-33: 1 0 x 1 hourly chart of the NASDAQ Composite Index

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Chart 5-37: 2% x 3 ofthe NA$DAQ Composite Index

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Stops in Point and Figure analysis

You will recall that there are two questions you must ask yourself and then answer before placing a trade: ‘What do I do if! am wrong?’ and ‘How do I know I am wrong?’ The answer to the second question relates to the level at which you no longer believe the signal to be valid. There are two ways to handle this.

The Point and Figure way is to look at the pattern that made you take the signal in the first place and ask yourself what would have to change to make the signal invalid. The answer is easy in 3 -box reversal charts because a double-bottom sell after any buy signal is your stop to close the long, and a double-top buy after any sell signal is your stop to close your short. You will recall, however, that in most cases it is best to look left in the pattern to determine where your stop will be placed, which is often not on the first double signal in the opposite direction, but rather a row or two away from it.

In I -box reversal charts, if the pattern is a bullish semi-catapult or fulcrum, there are two places to position your stop, depending on the depth of the pattern. If the pattern is shallow, perhaps 2 to 4 boxes deep, as many semi-catapults are, then the stop should be placed one box below the low of the pattern. If the pattern is deep, as most fulcrums are, then the stop should be placed one box below the pivot or anchor point of the pattern in the case of a fulcrum bottom,.or one box above in the case ofa fulcrum top. Remember the pivot row is the row at which your horizontal count is taken, that is to say the row with most filled in boxes.

In all cases, the risk-reward ratio should be determined as this will affect whether you take the trade, and, if you do, where you place your stop.

Standard percentage stop losses

Good money management is the key to successful trading, whether you use Point and Figure or some other method to generate entry signals for you. Consequently, a simple percentage trailing stop loss, based on the volatility of the instrument, is used by many as the exit stop. The advantage is that all you have to do is look for entry signals based on your knowledge of Point and Figure charts, and then use a trailing stop to exit the trade. The disadvantage is that, after exiting on the break of a trailing stop, there may not be an opportunity to re-enter the trade.

Stop losses the Point and Figure way

If you think about it, Point and Figure already has a trailing stop mechanism built into it if you use log scale charts. A 2% x 3 log scale chart means that the price must fall by 3 boxes or 6% from the last plotted box to trigger a column of Os. So, by adjusting your box size and your reversal, you can have an inbuilt stop loss. If you wanted a 1 0% stop loss, you would need to use a 2% x 5 or a 1% x 10 or a 3.3% x 3 chart. The problem is that charts with odd sized box sizes and reversals like these are no good for entry signals, so you must operate two

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charts. Ifyour chosen stop is 10%, then you should use your standard 2% x 3 or 1% x 3 chart to obtain your entry signals and once you are in the trade, you switch to a 2% x 5 or 3.3% x 3 chart to wait for the exit on the first appearance of a column of Os.

Some may argue that this is a rather roundabout way of running a trailing stop, but the two methods are not quite the same. The simple trailing stop method subtracts 10% from the highest price reached and uses that as the stop level. No regard is taken of any Point and Figure rules. With Point and Figure however, you will recall that once a box has been plotted, the price which achieved it is forgotten and all measurements for reversals are taken from the value of the last box plotted. So, a 10% reversal or the appearance of the column of Os is based on a reversal from the last X plotted. It is a less ‘noisy’ way of using a stop loss.

The method you choose is up to you. The very fact that you have chosen a way of exiting a trade means that you are one giant step down the road to success.