We all like to hear things straight, without the waffle. This is especially true when we're analysing financial markets. There are literally thousands of different assets that we can trade, and simply not enough time to get to grips with even a small fraction of them. Therefore, we need methods that help us cut to the chase.
Point-and-figure (P&F) charting is a great way of getting to the heart of the matter. P&F charts display price-action in columns of noughts and crosses. What makes them different is that only relevant price movements are shown. All the sideways movement and go-nowhere stuff is ignored.
The chart below shows the FTSE 100 in P&F format. The blue columns of crosses represent rising prices, while the red columns of noughts represent falling prices. Notice how easy it is to get a feel for the trend of the market at a glance.
Each nought or cross occupies a box within a column, here representing 50 index points a piece. So, five blue boxes would equal a gain of 250 points in the FTSE 100. It is up to the chartist how many points each boxes on a P&F chart represents and depends on whether you want a longer-term view or a shorter-term one.
The columns switch from noughts to crosses and vice versa when the price reverses in the opposite direction by a certain number of boxes. In this case, the switch occurs every time the price reverses by at least three boxes in the other direction. Once again, the settings are up to you - in this case, I simply instructed my ShareScope package to construct the chart this way.
By only showing price movements of a certain amount, we get a much cleaner, more straightforward chart. If the price doesn't really change, the P&F chart doesn't change either. By contrast, conventional charts display every last blip and wrinkle, however meaningless.
Because they show only the movements that matter, the signals that come from P&F charts are clear and unambiguous. The bullish and bearish formations are fairly standardised. This makes interpretation much easier than with other charts, which can require a lot of subjective judgement.
When the price breaks above the top of a bullish formation, it is a buy signal and when it falls beneath the low of bearish formation, it is a sell signal. Because of the box system, it is always immediately obvious when such a move has taken place.
Likewise, P&F charts make it easier to decide where to place your stop-loss. There is always an obvious level at which the pattern would cease to mean what you thought it did, and that can serve as your get-out point. This doesn't mean you don't have to think for yourself, just that it makes the thought-process quicker and simpler.
Just as the messages of P&F charts are clear, so are the price-targets that they generate. Objectives are found by measuring the height and width of groups of columns and then projecting the number of boxes higher and lower.
There are some drawbacks to P&F charting. Because they ignore a lot of price movement, you can't use them in any method that considers time factors, such as Elliott Wave or Gann analysis. And while they give clear messages about whether a price has broken out, they are not as good as say, candlestick charts for determining the significance of the breakout.
For this reason, P&F charts may best be used in combination with other types of chart. For example, you might use P&F charts for scanning rapidly for opportunities and then switch to more detailed candle-volume charts in order to perform in-depth analysis of a promising situation.
If you want to learn more about this fascinating branch of technical analysis, one of the best books on the subject is Thomas Dorsey's Point and Figure Charting: The Essential Application for Forecasting and Tracking Market Prices. You can buy it at a 15 per cent discount in the IC bookshop (www.investorschronicle.co.uk/bookshop)
