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Stock Charts, Analysis, Market Comment and Stockpicks from our in-house team of expert analysts. Stockcube
produce a comprehensive range of Technical Analysis Research Services – visit www.stockcube.com
The following copy is taken from www.chartanalysts.com, Stockcube Research’s point and figure charting
resource.
If you are visiting this website, there is good chance that you already have a keen interest in Technical
Analysis, however, it is always worth taking a moment to consider the nature of Technical Analysis
and how we might use it.
What is Technical Analysis? Quite simply, Technical Analysis can be defined as the study of investor
behaviour and the subsequent price action. The only data that we need to perform our studies are
the price histories of the instruments. This data alone (which may also include time and volume
information) will enable us to form our view.
Technical Analysis vs Fundamental Analysis. Fundamental Analysis concerns itself with establishing
the value of stocks and other instruments. The fundamental analyst will concern himself with financial
statements, demand forecasts, quality of management, earnings and growth etc. He will then make a
judgement on the share or commodity price, often relative to its sector or market peers as being over
or undervalued. The majority of research that you will receive from Brokers on Investment Banks will
be based on company fundamentals. At Chartanalysts, while we would not dismiss the work of many
talented fundamental analysts, we take a more pragmatic approach; our view is that the investor
sentiment is the single most important factor in determining an instrument’s price.
A good historic example of this was the instance of many leading UK value-based funds falling into the
trap of buying “cheap” “old economy” stocks in the mid to late 1990’s. The problem? As investors
continued to put their money into TMT, “old economy” stocks kept getting cheaper! Technical analysts
were able to avoid this trap by establishing that value stocks were in downtrends. In a nutshell, the
fundamental analysts were making decisions based on their own (subjective) opinions while the
technical analysts were listening to what the market was telling them.
We believe that Technical Analysis holds the key to determining investor sentiment. Some
investors and market “experts” believe that the two disciplines are mutually exclusive. We would
dispute this theory. Many successful traders use a combination of fundamental stock selection
procedures and technical analysis timing filters with excellent results.
History
It is probably not unreasonable to assume that all civilisations where commerce has flourished have
had traders who pay close attention to prices and their movements. However, rather than dwell upon
the wonders of the Phoenician market for olive oil forwards, our story starts with one Charles Dow,
inventor of the first stock market index in 1884. Mr Dow wrote a series of articles for the Wall Street
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Journal in the later years of the 19 century. This body of work was later to be known as “Dow Theory”
and formed the basis of what we know as Technical Analysis. While we will not go into the finer details
of Dow Theory in this piece, the most important concepts that Mr Dow recognised were that prices
reflect the current balance of supply and demand (i.e. the hopes and fears of investor), and most
importantly, defining the concept of trend. We will be looking the concept of trend in a little more detail
later on in this piece.
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Certainly, the concept of studying price action was fairly well established in the early part of the 20
century. One of the greatest books on trading ever written is “Reminiscence of a Stock Operator”, first
published in 1923. Its author, a Mr E. Lefevre wrote that he “would study the changes on the tape,
always looking for the repetitions and parallelisms of behaviour”. Although Mr Lefevre might not admit
it, he had undoubtedly become a technical analyst.
Our story now takes us to the highly regarded book written by AW Cohen, the founder of Chartcraft.
Published in 1947, “Stock Market Timing” was quickly to become the bible of point and figure charting.
One of Mr Cohen’s many contributions to the field of Technical Analysis was the establishment of the
Since this time, Point and Figure charting has moved in and out of fashion with investors in a variety of
asset classes. It is currently undergoing a renaissance amongst professional equity traders as the
current choppy market conditions make P&F disciplines invaluable for establishing key trends and
areas of supply and demand. The advent of computerised chart construction and web-based delivery
also means that P&F charts are available in a wide range of instruments to all investors, be they
market professionals or private individuals.
The primary tool of all Technical Analysts is the chart. Chartanalysts is the market leader in Point and
Figure Charting. These charts differs from conventional line, bar or candle charts in several major
aspects:
• There is no fixed time axis: A point and figure chart only moves along the X-axis when a
trend reversal takes place. For example, an instrument trading a very narrow range for and
extended period of time will simply be represented by a single point, not a horizontal line.
• Noise reduction: a conventional high/low/close chart will show the ranges of every single
trade on the day. At Chartanalysts, we use only the closing price. Furthermore, extended
small range trading periods will be smoothed by the construction method, enabling to user to
quickly establish the primary trend and key areas of supply and demand.
• Simple visual representation; Rising prices are shown by a vertical line of XXX’s. Falling
prices are shown by a vertical line of 000’s
So, let’s have a look at how we might construct a sample point and figure chart. We are going to use
a recent 5-day trading period of Microsoft as an example. NB; remember that only closing prices will
be used.
Monday 70.14
Tuesday 71.14
Wednesday 72.74
Thursday 73.00
Friday 70.40
First, we must choose the scale. Over the last few months the stock has traded a range of 45 to 75, so
we’re going to choose a scale of one unit equals one dollar. If the stock had traded a wider range, or
has experienced a larger move, we might choose a different scale. In this instance we will also be
rounding up or down to the nearest whole number.
Let’s start from Monday. The stock has been in an uptrend for a few days, so we start with and X.
Hence:
70 X
73 X
And now Wednesday’s and Thursday’s closing prices: 72 X
71 X
70 X
We can now see a clearly displayed uptrend. But what happens if we add Fridays’s closing price of
70? Now the chart will look like this:
73 X
72 X0
71 X0
70 X0
The point and figure chart is now showing that there has been a change of trend and a clear visual
signal is given. Chartanalysts use the three-box reversal method of chart construction. This means
that the price has to move more than 3 units in the opposite direction before we show a change of
trend. Had the price only declined to, say 72, the column of XXX’s would have remained intact. The
purpose of this technique is to smooth out minor market moves and focus on the underlying trend.
The basic premise of P&F charting is that the law of supply and demand governs the price of a stock
or other financial instrument. There are three possible scenarios:
1) An uptrend, indicated by a rising column of XXX’s. From this we ascertain that demand has
overcome supply.
2) A downtrend, indicated by falling column of 000’s. From this we ascertain supply has
overcome demand.
3) An interruption of these vertical columns by short alternating columns of XXX’s and 000s .
This indicates Supply and Demand contesting for supremacy. This may indicate a potential
change of trend, or simply be a continuation pattern (trend and countertrend).
We use P&F charts to establish the trend, to identify previous areas of supply and demand and
to determine when there has been a change of trend.
It’s always interesting to try and pick the tops and bottoms in stocks, but Dow Theory tells us that a
trend is more likely to continue than change. We must assume a trend is in place until we see a clear
indication otherwise. The wise trader will ascertain the underlying market condition, be it an uptrend, a
downtrend or a range-trading environment before opening a position. Reversals or changes of trend
can be excellent opportunities for exploiting the speedy and major moves that often follow, however,
Some Signals
You may be asking, how do I tell a continuation pattern from a change of trend? Point and Figure
charting has the answer. Here are a few of the signals that we use at Chartanalysts.
P&F charting can supply you with entry levels and timing, profit targets and stop-loss levels. What it
cannot supply a trader with is discipline. We are all aware of the theory of “run your profits and take
your losses”, but as you may well be aware, human nature tends to greedily take profits a the first
opportunity while hoarding our failures in the hope that they “might recover one day”.
X
X XO
P&F will supply you with clear stop levels and XOXO
identification of trend to help you avoid these XOXO
problems in addition to supplying you with entry XO O
and exit signals. Let us suppose that we are X X O Lower Low
running a long position in an instrument that XOX
displays an orderly trend and countertrend XOX
uptrend. When can identify that this uptrend has XO
broken? The answer is, when the instrument X
posts a lower low (see example). This would a X
suitable level for a stop loss or exit point. X
David Fuller, Senior Global Strategist at Stockcube Research has been running The Chart Seminar
for over 33 years. This highly regarded two-day course in Behavioural Technical Analysis has been
attended thousands of delegates from many of the world’s leading Banks, Investment Banks and Fund
Managers as well as many serious private investors. For more information about our forthcoming
courses, please see our website.
And Finally
As with all skills, practice makes perfect. We recommend that you start applying Point and Figure
charting techniques to your portfolio, trading book or model portfolio at the earliest opportunity.
ShareStar has a stable-mate point and figure charting website at www.chartanalysts.com. You can
subscribe online to our services.