Point and Figure Charting: A Basic Introduction

Reviewed by Charles PottersFact checked by Jiwon Ma

Point and figure (P&F) charts are designed for long-term investment. They’ve been described as one of the simplest systems for determining solid entry and exit points in stock market trading. This charting system monitors the supply and demand of each issue while keeping an eye on developing trends. What makes P&F charts unique is that they don’t account for the discrete passage of time as most other types of charts do along their x-axis.

Point and figure charting has never been at the top of the list of the most popular techniques used by technical analysts but there’s a growing interest in P&F from all corners of the charting community.

Key Takeaways

• Point and figure charts are a way to visualize price movements and trends in an asset without regard to the time that passes.
• P&F charts use columns consisting of stacked Xs or Os, each representing a set amount of price movement.
• The Xs illustrate rising prices and the Os represent falling prices.
• Some argue that support and resistance levels and breakouts are more clearly defined on a P&F chart because the chart filters out tiny price movements.
• P&F charts are less susceptible to false breakouts.

Constructing P&F Charts

The conventional technical analysis chart tends to be an open-close/high-low chart that plots price movements over time such as from day to day. The emphasis is only on the closing price of an issue in the creation of a P&F chart. The developers of P&F charting were interested in trend development. They weren’t concerned with the noise created daily by minor moves up or down. Their focus was on how the larger picture played out from a supply and demand perspective.

The key to P&F charts is the establishment of the unit of price, which is the unit measurement of a price movement plotted on the graph. There’s no time axis on P&F charts, only a price axis. Rising stock prices are shown with Xs and falling prices are shown with Os.

Important

These points appear on the chart only if the price moved at least one unit in either direction.

It would appear as a column of three Xs if the closing prices of a stock moved up one price unit three times. The chart shows a new column of Os if the price movement reverses direction. An O is plotted for each unit of movement. Xs and Os never appear in the same column. The chartist must establish how many price units make up a box and this is how much the price must move in the opposite direction for the chart to begin a new column.

Example of a P&F Chart

Let’s say a stock you were tracking was trading at $25. You were using a $1 unit measurement and a reversal box is three units. The stock would have to close at $22 before the chart would reverse to a column of Os if it had been trading upward to $25. Each unit of price movement down from the $25 level must be represented by one O in this new column of Os.

The next reversal would have the stock trading up at least $3 or three points before a new column of Xs came back into view on our P&F chart. Assume the issue continues to fall to $20 before reversing itself. The Xs would reappear when the price hits $23.

Remember, you choose the unit size. It could be $0.50, $1, or even $2 if the stock price is high enough. Graphically, the first two columns of our example would look like this:

Reading P&F Charts

It’s clearly understood by P&F experts that the law of supply and demand determines the price of a stock. They believe that demand has overcome supply if the issue is rising in price and they have an uptrend in place with at least three Xs.

The reverse indicates that supply has overcome demand when the chart gives three Os. P&F charts show the establishment of trends, trend reversals, and the supply and demand of charted issues.

Here are some examples:

This chart gives you a solid base to further study two important principles of P&F charting: support levels and resistance levels. Both support and resistance are shown in horizontal lines and trendlines that are represented with 45-degree angles.

Support Levels

A support level is a level at which investors and traders believe that prices will start to move higher after hitting the support mark. Look at the three Os in the example above. A horizontal row of Os is what you’re looking for when you’re zeroing in on a trend reversal and an uptrend to begin.

Resistance Levels

A horizontal row of Xs marks the resistance levels you want to look for in the P&F charting study. Studies of trendlines have shown that breakthrough resistance levels generally occur with great gusto, big volume, and a rapidly increasing stock price.

What Is the Law of Supply and Demand?

The concept of supply and demand has been around for centuries. It dictates that the price will increase as a stock becomes more available and more buyers want to acquire it. Demand then overtakes supply. Prices drop when supply and demand drop.

What Is the Timeline for a Long-Term Investment?

The timeline for long-term investment is at least three years and some put it even longer at five years. Temporary and volatile market conditions have less effect on these investments because they have ample opportunity to potentially rebound if you’re going to hold them for this length of time.

How Can I Learn More About P&F Charting?

The best book written on the subject is “Point and Figure Charting” by Thomas Dorsey. It’s a must for those who want a thorough understanding of this charting method. P&F charts have been deeply integrated into other technical analysis and trading strategies since their introduction.

Bottom Line

Trends take a long time to reverse so traders should keep in mind that P&F charting is designed for long-term investors. It has no value for the short-term trader. Technical investors can take positions that have a strong probability of profiting by using point and figure charting to identify overall price trends.

Disclosure: Investopedia does not provide investment advice; investors should consider their risk tolerance and investment objectives before making investment decisions.

Read the original article on Investopedia.