There are two parameters required for plotting a point & figure chart, box size and reversal size. Box size refers to either a single price or a range of prices. Reversal size is the variation of price, the number of boxes, before a new column is started. Both parameters should be selected by the user.
The charts are compiled using a series of columns made up of X’s and O’s. The X’s indicate a market rallying, price going higher, while the O’s signal a falling market, price moving lower.
The chart above has a box size of 1 and a reversal size of 5. The convention for starting a new column of X’s is that a new column begins one tick above the low of the previous column. This can only be plotted once the required number of price boxes, have been reversed. Conversely the O’s start after the required reversal and are plotted starting one tick below the high of the X’s in the previous column.
The minimum number of X’s or O’s in the above chart is therefore four, given that we must leave the first price of the reversal uncharted. The second last column has only four X’s. The reversal started at 4213, but that price isn’t plotted. The X’s aren’t plotted until the market trades at 4217, five ticks or boxes above the low at 4213, including 4213.
A point and figure chart has several advantages to a classic bar chart, the most obvious being that support and resistance are clearly defined. This is most probably a result of the reduction of, what might be referred to, as noise. Sometimes there can be just too many lines on the page.
If the box size is increased, the noise can be reduced even further. This is a great tool for constructing longer term charts over wide price ranges. In fact, using daily data or even straight out tick data, one can construct the equivalent of a normal weekly or a monthly bar chart.
Pit traders often employ point and figure charts as they can be maintained quickly and easily by hand. They divulge a lot of information in a format that is easy to interpret.
The above chart uses a box size of 2 ticks and a reversal of 5, which is equal to 10 ticks.
How to Use Point & Figure Charts
The reversal parameter is usually double, or triple, the box size parameter. It’s always a multiple of the box size. Therefore the larger the box size the more vertical data can be incorporated into the chart. Large box sizes are useful when compiling long term charts. The horizontal component, the width of the chart, is determined by the size of the reversal. The larger the reversal size the fewer columns will be required. In the example below a box size of 5 has been used with a 3 box reversal, which is equivalent to a 15 point turn around.
All the classic formation techniques can be applied to a point & figure chart. In the example above there are two distinct formations. The first is an up sloping wedge, which gave rise to an uptrend line and a resistance level at 4245. This resistance turned into support after price had broken out to the upside.
The next formation is a flag, which established new support and resistance levels at 4265 and 4290. A breakout or a breakdown from this flag formation will issue an appropriate buy or sell signal. There’s a higher probability for the market to break out than breakdown given the formation is a bull flag. The bull flag has an up pole, a vertical move to higher prices preceding the flag.
You will notice the market popped up to 4295 in an attempt to breakout to higher prices, but this price probe above the flag was subsequently rejected. The initial signal is to go with the breakout and buy the market. However, failure to sustain the breakout and a move back into the flag formation negated the buy signal and in fact issued a new sell signal.
The sell signal is valid until the market either breaks out to higher prices or reaches the next support level. In this case, the support levels come first from the trendline, which cuts through at 4270. The next support occurs at the lower side of the flag formation at 4265.
A break of the trendline is unambiguous when using point & figure charts and in this case the sell signal was confirmed with a break of the support level at 4265, the lower side of the flag formation.
There was old resistance at 4245 from the first formation and that now becomes support.