Point and Figure Charts

The most common methods of representing the price action of a security on a chart are lines, bars and candlesticks. However, there is yet another form of price representation namely point and figure chart. The uniqueness of point and figure chart is that it does not plot the price movement against time but only against the changes in the trend. Thus, significant changes in price will only alter a point and figure chart.

Setting up P&F chart


A point and figure chart enables a trader to precisely identify the price points where the potential break outs (change in supply/demand relationship) may happen. This in turn allows a trader to easily map the probable future price trend of an asset.

Understanding a point & figure chart

A point and figure chart is made up of columns of ‘X’s and ‘O’s, which symbolizes assorted price movements. A column of ‘X’ indicates a rising price while a column of ‘O’ represents a decline in the price of an asset. Each of these symbols (‘X’ and ‘O’) makes up a box, which indicates a predefined value of price movement. Additionally, price reversals, if any, begin in a new column. A typical Point & Figure chart is provided underneath (plotted using free Cute Point & Figure v1.1 indicator for MetaTrader 4):

Typical P&F Chart

The quantum of price movement necessary to begin a new column can be modified by the trader using the settings named ‘Reversal Amount’. Thus, ‘Reversal distance’ is the size of the box multiplied by the ‘Reversal amount’. This means that as long as the reversal distance is not breached, the prevailing column will continue.

P&F Indicator Settings

Once the reversal or threshold distance is crossed then a new column begins and develops in a totally opposite direction to the previous one. By convention, ‘X’ is always plotted above ‘O’ and vice versa. You can use many P&F indicators to build similar charts.

Calendar markings

An important thing to keep in mind is that P&F charts do not show time in a linear fashion. Thus, depending on the price movement, each column can represent a single day or several days. So, each mark, irrespective of whether it is ‘X’ or ‘O’, indicates a significant price movement since minor changes (noise) is filtered. Additionally, each and every new calendar day, month and year are marked on the chart, as shown above, for easy study and analysis of price data.

Determining box size

One of the four different methods, described underneath, is used to select the box size. They are:

Classic scaling

Also referred to as normal scaling, the method involves the use of ready-made table, which defines the box size for different price ranges. Traders usually refer to the table (given underneath) provided in the book named “Point & Figure Charting” written by Tom Dorsey. The classic scaling method replaced the previous method of fixing the box size at $1.

Price range of traded asset Box size
Below 0.25 0.0625
0.25 — 1.00 0.125
1.00 — 5.00 0.25
5.00 — 20.00 0.50
20.00 – 100 1.00
100 – 200 2.00
200 – 500 4.00
500 — 1,000 5.00
1,000 — 25,000 50.00
Above 25,000 500.00

 

Percentage (log) scaling

This method uses a fixed percentage of the stock price (based on the previous box below) to construct the box. For e.g., an input of 2 (i.e., 2%) for a $50 stock would create a box with a size of $1. This type of scaling is preferred when a stock undergoes substantial price changes.

User-defined scaling

The size of box, in this case, is determined by the trader as per the filtering needs. As the box size becomes larger the number of reversal signals will become lesser.

Average True Range (ATR) Scaling

In this method, the size of the box is decided based on the Average True Range of the asset. The default setting for ATR is 20 days. Being a dynamic method, there can be a noticeable change in the box size resulting in re-painting of signals.

Price options

The price used to calculate the box size can be one among the following:

  1. High or low price: When this option is enabled, either high or low price is selected. Sometimes, depending on the situation, both are ignored. The rule for the high or low price option is as follows.
    1. When the price is rising (uptrend). Use high when another ‘X’ can be drawn (ignore low). Use low when it triggers a 3-box reversal and another ‘X’ cannot be drawn (ignore high). Ignore both when the low does not trigger a 3-box reversal and the high does not call for another ‘X’.
    2. When the price is falling (downtrend). Use low when another ‘O’ can be drawn (ignore high). Use high when it triggers a 3-box reversal and another ‘O’ cannot be drawn (ignore low). Ignore both when the high is not sufficient to trigger a 3-box reversal and the low does not necessitate another ‘O’.
  2. Typical price: An average of the high, low and closing price is used to determine the box size.
  3. Closing price: Only the closing price is used to calculate the box size.

Constructing P&F charts

There are two well known ways of constructing a P&F chart. They are:

De Villiers’ method

As per this method, both the box size and the reversal setting are fixed at $1 and 1 respectively. Ultimately, this results in the creation of ‘X’s and ‘O’s in the same column and requires intraday data. Thus, the method, even though earliest, became unpopular soon.

3-box reversal method

This is the most popular method used by traders across the globe. The reversal setting used is ‘3’ in this case. Thus, a box size of $5 with a reversal setting of 3 will result in a reversal distance of $15 ($5×3). So, an upward trending asset will have only ‘X’ column until the price declines by more than $15 (reversal distance) from the peak. When the $15 reversal distance is breached, a new ‘O’ column would develop. Similarly, in the case of a decline, only a rise of $15 from the low would result in the formation of a new ‘X’ column.

In a case where the trader uses percentage scaling, a 1% box size with a reversal setting of 3 will result in a higher reversal distance during an uptrend and lower reversal distance in the case of a decline in the price of an asset (3% of 30 is higher than 3% of 28).

A 3-box reversal will cover anywhere between 9–24 months time on a chart. Thus, an increase in the box size will correspondingly increase the time covered on a chart. On the other hand, reducing the data period (for e.g., daily to intraday) and box size will result in increased sensitivity to the changes in price.

Trend analysis with P&F charts

Identifying trend is a major objective of any analysis and in this regard, a P&F chart offers invaluable assistance to a trader.

A P&F charts enables a trader to identify the trend with the same effectiveness as bar and candlestick charts. The trend analysis is done as described below:

Bullish & Bearish trend line

It should be remembered that a bullish trend line is always drawn at a 45° angle while a bearish trend line should be drawn with a 135° (45° turned upside down) slope. A lower rate of ascent (sideways price movement) usually leads to a break out.

Bullish Trendline on Point-and-Figure Chart

A long position should be taken when the price trades above the bullish trend line. All bearish signals should be discarded at that time. Similarly, a short position should be taken when the price trades below the bearish trend line. All bullish signals should be rejected in such instances.

Bearish Trendline

A 3-box reversal below the bullish trend line indicates an end to the uptrend scenario. Likewise, a 3-box reversal above the bearish trend line signals an end of the downtrend scenario. In such circumstances, a trader should close the long or short position and monitor the price action for the next trading opportunity.

Another point to remember is that a break out or break down is confirmed only when a trend line is broken clearly. There are situations where the price extends till the trend line thereby indicating a change in the rate of ascent. This does not mean a break out. The image below shows an example where the trend line is touched often but without a successful reversal.

Trendline with No Breakout

Contrary to the belief of beginner traders, a Point & Figure chart can be used to trade binary options as well. A P&F chart does not give importance to time. On the other hand, success in binary options depends on the timing of entry in particular. However, the contrast between the two can be nullified through proper settings. To trade binary options efficiently using P&F charts, the settings should be fine tuned for short expiry periods. To put it simpler, the box size and the reversal amount should be preferably 1pip and 1 respectively for trading 1min options. Such a setup allows more data to be displayed for analysis and identification of support and resistance level precisely. For 30min options, the box size and reversal amount should be a little bit higher. There are no hard rules for the settings. However, a trader should keep in mind that the final setting should allow precise (down to the final pip) identification of support and resistance level.

With a small box size and reversal setting, a trader will be able to analyze even the smallest price movement (necessary for trading 1minute options). On the other hand, such a setup does not allow proper assessment of the prevailing primary trend.

To enable a proper view of the trend, the scale box (right click on screen->properties) should be adjusted such that the lower and upper boundaries of the scale (Y-axis) is reduced to include only a small but relevant portion of the price movement (around 40–50 pips). Once done, the setup will look as below (EUR/USD chart with 1box reversal).

Adjusting P&F Scale

Chart patterns

A P&F chart facilitates spotting different kind of chart patterns (similar to candlestick patterns) as illustrated below:

Bullish chart patterns

  1. Double top break-out. This pattern consists of two ‘X’ Columns separated by a ‘O’ column. The second ‘X’ column forms the higher high while the first ‘X’ column indicates the trend. The ‘O’ column in between forms the confirmation of support. It is a common pattern and obviously has higher chances of failure.
    Double Top Breakout
  2. Triple top break-out. A triple top break-out pattern includes three X-columns and two O-columns. There will be two successive X-columns (with O-column in between) in the pattern with equal reaction highs. These consecutive X-columns indicate a resistance to the price movement. The final X-column will break above the previous X-columns to complete the triple top break-out pattern as shown below.
    Triple Top Breakout
  3. Ascending and Spread triple top break out.back-to-back double top break-out is referred to as Ascending triple top break-out. Likewise, a Spread triple top break-out is an expanded version (with another column of ‘X’s and ‘O’s in between) of the normal triple top break out pattern. The patterns are shown in the chart below:
    Ascending and Spread Triple Top Breakout
  4. Quadruple top break-out. Another ‘X’ and ‘O’ column added to a triple top break-out pattern results in the formation of a Quadruple top break-out pattern as shown above.

All the patterns mentioned above are useful to trade binary options with expiry ranging from 1minute to 1day. A trader should adjust the box size and scale size as discussed earlier to clearly identify the trend, support and resistance level.

If the trend is upward, a trader should only look for bullish chart patterns (triple, quadruple, spread or multiple top break-outs). Once a trader identifies a developing pattern then a call option should be bought near the support level. Conservative and beginner traders can wait for the breakout to take a position. However, it should be noted that in the case of binary options, buying a call option (when the trend is up) near the support, without waiting for the break-out, is always the wisest decision.

Only such a move will keep the trader’s position safe. This is because, in the case of binary options, even a one pip move in favor of the trader will fetch the reward. If the trader suspects a triple top break out pattern then taking a call option during the end of the final ‘O’ column is the most preferred one. It will keep a trader’s position safe irrespective of whether the expiry is 1min or 1hour. Only a trend reversal can put the trader at loss. Even if the pattern extends into a spread triple top break out or quadruple top break out, still the trader has a very high probability of success because of the entry near the support level.

Moreover, the developing pattern (a triple top, quadruple top or multiple top break-outs) will instill confidence in the mind of a trader and keep him cool.

Quadruple Top on Point and Figure Chart

Bearish chart patterns

The prominent bearish chart patterns are:

  1. Double bottom breakdown
  2. Triple bottom breakdown
  3. Spread triple bottom breakdown
  4. Descending triple bottom break down and
  5. Quadruple triple bottom break down.

If the column of ‘X’s and ‘O’s are interchanged (in a bullish chart pattern) and the break-down happens in the ‘O’ column then it leads to one of the bearish chart pattern listed above. The self-explanatory charts below clearly illustrate the bearish chart patterns.

Muti-bottom Chart Patterns

More Bearish Patterns Examples

Again, all the bearish patterns can be used to successfully trade binary options (1minute to 1day expiry) as long as the settings are fine tuned to give a clear indication of the existing trend with support and resistance levels.

When the primary trend is downward then a trader should look for bearish patterns. The put option purchase should be made near or at the resistance level in the developing pattern (triple, quadruple, spread or multiple bottom break-down). Since there no possibility of further upside (unless there is a trend reversal), the entry price ensures a higher probability of success, irrespective of the expiry period.

Reversed bullish & bearish signals

A reverse bullish signal begins to develop with a series of ‘X’ and ‘O’ columns forming ‘higher highs’ and ‘lower lows’ respectively. The final ‘O’ column in this rising price pattern extends below the low of the previous ‘O’ column thereby indicating a reversal in the trend.

Reversed Signals

A binary options trader can purchase a one touch put option to benefit from the bullish reverse signal. Once the break-down begins, a trader can purchase a one touch put option. As long as the pattern is identified properly, there is little to no risk for the trader since there is no further uptrend or pull back left for the asset.

If the momentum is not strong enough to create a deep decline in price then the trader will lose the one touch put option trade.

Alternatively, a binary option trader can purchase a no touch option with price above the resistance (highest high in the ‘X’ column just before the break-down).

Since the chances of reversal are negligible, a binary options trader stands to gain anywhere between 200% and 500% from proper application of one touch and no touch binary options.

Any spikes above the resistance zone would render the no touch options useless. This may happen during periods of high volatility.

There are situations where a break-down is followed by a strong reversal (uptrend) because of economic or geo-political news. When there is a scheduled high-impact new announcement then a trader can purchase a double one touch option with price limits above the resistance and below the break-down. The trader will gain if the trend continues or if there is a strong reversal.

If the news halts the prevailing down-trend and does not cause any reversal then the trader will lose the double one touch options trade. This is a worst case scenario.

In the case of a bearish reverse signal, the final ‘X’ column breaks above the high of the previous ‘X’ column thereby indicating the beginning of an uptrend. The chart below indicates the formation of a reversed bearish signal pattern.

Reversed Bearish Signal Pattern

A binary options trader can purchase a one touch call option once the price break-out happens in bearish signal reversed pattern. If the momentum is not strong enough to create a steep uptrend then the trade will result in a loss (out of money expiry).

Alternatively, a no touch option with price below (recent lowest low in the ‘O’ column) the support can be bought as well. Again, in this case, a single spike below the support will make the options end out of money.

As long as the pattern is recognized correctly and the entry is done at the right time, the trader stands to gain between 200% and 500% from both one touch and no touch option trade.

A double one touch option trade can be entered if the trader is not sure about the trend. A double one touch option trade with price below the support and above the break-out will save the trader as long as the trend is strong. If the price does not touch either of the bands due to lack of momentum then the option will expire out of money.

Bullish & bearish catapults

pull-back after a bullish break-out or a retracement after a bearish break-down result in the formation of a ‘Bullish Catapult’ and ‘Bearish Catapult’ pattern respectively.

Bullish Catapult

Bearish Catapult

The ‘O’ column extends back into the Spread (or multiple) triple top break-out in the case of a bullish catapult. On the other hand, the ‘X’ column pulls back (weak attempt to rise again) into the Spread (or multiple) triple top break-down thereby resulting in a bearish catapult pattern.

Bullish and bearish triangles

A triangle pattern develops when ‘X’ and ‘O’ columns together form a series of lower highs and higher lows respectively. The break-out or break-down trigger determines whether the triangle is bullish or bearish. So, traders should wait for the beginning (through break-out or breakdown) of an uptrend or a down trend to enter a trade.

If the triangle formation results in a break-out then a trader can purchase a one touch call option. The trade will result in a 200% to 500% profit as long as the trend is strong enough to cross the option price before expiry. Any retracement or reversals will result in losing (out of money) the trade.

Triangle Formation on P&F Chart

A better alternative is to purchase a no touch option with price below the lowest low in the triangle pattern. The trader will benefit as long as there are no spikes or trend reversals. The yield will be in the range of 200% to 500% depending on the risk and volatility of the underlying asset. Even if the price reverses and touches the lower band once, the option will result in out of money expiry.

If the trader is interested in taking a position before the break-out or break-down happens then a double one touch option is the most suited one. As long as the trend remains strong after break-out or break-down, the trade will result in a profit (in the money expiry). If the price does not touch (weak momentum) either of the bands then the trade will result in a loss.

If the triangle formation results in a break-down then a trader can purchase a one touch put option. As long as there is a strong decline in the price, the option will end in the money thereby resulting in a profit ranging between 200% and 500%. However, loss of momentum will result in the worst case scenario (option expiring out of money).

A no touch option is always a better alternative for a triangle break-down pattern. A no touch option above the highest high (‘X’ column) in the triangle pattern can be purchased. As long as the price does not reverse the trader will benefit. Only a strong reversal or upward spike can result in a loss. As long as the upward boundary of the triangle is not violated, the trader will make appreciable gains.

A trader who is willing to enter a binary options trade before the break-out or break-down of the triangle pattern can enter a double one touch options trade. As long as the trend is strong enough to hit at least one of the price levels, the trade will result in a profit (in the money expiry). Only a weak momentum with a range bound movement after break-out or break-down will result in a loss.

 

Traps (bull & bear)

When the price reverses after a one box break out, the resultant formation is a bull trap. Similarly a one box break down followed by an uptrend in the price gives rise to a bear trap. As the name suggests, a bull and bear trap is usually seen before the beginning of a down trend and up trend in price respectively. The scenario ensures that bulls and bears are trapped off guard.

Bull Trap

Bear Trap

Forecasting target price

There are two ways of calculating the price target in a P&F chart. They are:

  1. Horizontal count method. To calculate the probable target price, the foremost thing to be done by a trader is to identify the congestion zone (pattern which forms the break out). The width of the congestion zone is then multiplied by the box size and reversal amount. Finally, the value is added (long position) to the lowest price in the pattern (triple top break out etc.,) or subtracted (short position) from the highest price in the pattern (triple bottom break down etc.,) to get the probable price target. The image below clearly explains how a price target is calculated in a P&F chart using the horizontal method.
    Horizontal Count Method
  2. Vertical count method. In this case, the width of the pattern has no relevance. However, the height of the pattern determines the price target. To calculate the price target for a long position, a trader should count the number of ‘X’s (in the pattern) next to the column with the lowest (immediately near to the pattern) price point. It is then multiplied with the box size and the reversal amount to determine the probable price distance. The value is then added to the lowest price point to arrive at the target price.
    Vertical Count Method

To calculate the price target for a short position, the number of ‘O’s to the right of the highest price point in the pattern is counted and then multiplied with the box size and reversal amount. The final value is then subtracted from the highest price point to arrive at the probable price target.

Advantages of P&F chart

  • Removes unwanted noise because of 3-box rule.
  • Allows a trader to focus on major price movements
  • Removes time constituent from analysis.
  • Enables easy identification of support/resistance levels.
  • Trend forecast can be done easily as the signal from the chart is either a buy or sell and well-defined.
  • Stop loss and take profit levels can be calculated for every breakout.

Trading with P&F charts will be easier as long as the trader has sufficient knowledge to determine a suitable reversal amount. In the initial stages, a trader can try different reversal amount settings and determine the most suited one using the historic chart signals. Additionally, a trader should develop the ability of spotting crucial price patterns. Once a trader develops the discussed traits, successful trading decisions can be made with confidence. You can use this analytical technique with any binary options broker.

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