OVERVIEW
The point and figure chart is a member of the genre of charts normally referred to as reversal charts (Figure 1). A reversal chart is any chart that filters the raw OHLC data in order to accentuate significant points of interest while ignoring points of less interest. All technical analysts find peaks and valleys of great interest, whereas they find areas of lateral price movements less interesting. Peaks and valleys are those points of inflection where price directions reverse and the slope of an existing trend changes its arithmetic sign (minus to plus and plus to minus).
The point and figure chart is a member of the genre of charts normally referred to as reversal charts (Figure 1). A reversal chart is any chart that filters the raw OHLC data in order to accentuate significant points of interest while ignoring points of less interest. All technical analysts find peaks and valleys of great interest, whereas they find areas of lateral price movements less interesting. Peaks and valleys are those points of inflection where price directions reverse and the slope of an existing trend changes its arithmetic sign (minus to plus and plus to minus).
HISTORY
The point and figure chart (also called the three-box reversal method), created in the late nineteenth century, is roughly 15 years older than the bar chart and is probably the oldest Western method of charting prices in existence. Its roots date way back in trading lore, and it has been intimated that this method was used successfully by the legendary trader James R. Keene during the merger of U.S. Steel in 1901. Mr. Keene was employed by Andrew Carnegie to distribute ownership, because Carnegie refused to take stock as payment for his equity interest in the company. Keene, using point and figure charting and tape readings, managed to promote the stock and get rid of Carnegie’s sizable stake without causing the price to crash.
 |
| Figure 1 Point and Figure Chart. |
The point and figure method derives its name from the fact that price is recorded using figures (X’s and O’s) to represent a point, hence point and figure. Charles Dow, the founder of the Wall Street Journal and the inventor of stock indexes, was rumored to be a point and figure user, and the practice of point and figure charting is alive and well today on the floor of the Chicago Board of Trade (CBOT). Its simplicity in identifying price trends, support, and resistance, and its ease of upkeep have allowed this method to endure the test of time, even in the age of Web pages, personal computers, and the information explosion.
ANATOMY
Price advances in a point and figure chart are represented as vertical columns of X’s, whereas price declines are represented as columns of O’s (Figure 2).
 |
| Figure 2 Point and Figure Chart Anatomy. |
Two user-supplied variables are required to plot a point and figure chart, box size and reversal amount.
BOX SIZE
Traditionally, the minimum price unit is the smallest fractional price increment that a quote currency (or underlying security) can change. In the currency markets, this increment is a single pip. For example, if the EURUSD currency pair is currently trading at 1.2451, a single pip is 0.0001 USD.
There are three cases where a box size greater than 1 pip might be used. One such case is when the parity rate between two currencies is very wide and causes a very large bid/ask spread. For example, if the bid/ask spread (transaction cost) for the EURCZK currency pair is 350 koruny, then a 1-pip box size will have very negligible filtering power.
A second reason for using a box size greater than 1 pip occurs when performing historical analysis and a longer time frame is being analyzed. In this case, the analyst probably will be scrutinizing major reversals and may have little interest in minor reversals. This pertains more to position traders than to session or day traders.
REVERSAL AMOUNT
The reversal amount is the number of boxes necessary to plot a reversal in price direction. For instance, if the current trend is upward and the reversal amount is set at three boxes, then a decline of three box units must be reached before the downward movement is plotted. If, instead, a new price continues in the same direction as the existing trend, then single boxes are added automatically to the last extreme (either a peak or a valley).
It is the interaction between the box size and the reversal amount that triggers the reversal mechanism in the reversal algorithm necessary to plot new columns of X’s and O’s while ignoring lateral price movements.
There is one final case for increasing box size. If an analyst, for whatever reasons, has become very partial to one specific reversal amount, it is possible to increase the box size instead of the reversal amount when market conditions change.
For example, a three-box reversal amount is favored by many traders. If traders wish to filter out some of the minor reversals, they can increase either the reversal amount or the box size. However, keep in mind that although an algorithm with a 2-pip box size and a three-box reversal amount will generate results very similar to those of an algorithm with a 1-pip box size and a six-box reversal amount, they will not be identical. This requires some reflection. The reason is that when you plot a continuation of an existing trend, smaller distances can be plotted when a smaller box size is used.
A detailed study of point and figure charts can be found in Forex Chartist’s Companion, by Archer and Bickford (Wiley, 2007).
