Point-and-Figure (P&F) Chart

Point-and-Figure (P&F) charts are a type of financial chart used to track price movements. Unlike traditional charts such as candlestick or bar charts, P&F charts focus solely on price changes and discard time-related trends. This makes them particularly useful for identifying long-term trends and support/resistance levels.

Basics of Point-and-Figure Charts

P&F charts are constructed using a series of columns of X’s and O’s. Each X represents a certain price increment, known as a ‘box’, by which the price has increased, and each O represents a corresponding decrease. The chart ignores the passage of time and only moves to a new column when the direction of the price trend changes by a specified amount, known as the reversal amount.

Key Elements:

• Box Size: This is the value represented by each X or O. It can be user-defined or based on a default setting like 1 unit of currency (e.g., $1 for stocks).
• Reversal Amount: This indicates the number of boxes that must be moved in the opposite direction to warrant a new column. For example, a 3-box reversal chart will shift to a new column when the price moves down by three boxes if it was previously moving up.

Constructing a Point-and-Figure Chart

Step-by-Step Construction:

1. Setup Initial Price Movement: Begin plotting X’s (for price increases) or O’s (for price decreases).
2. Continue Plotting: Keep plotting in the same column until the price changes direction by at least the reversal amount.
3. Change Columns: When a reversal occurs, move to the next column and start plotting in the opposite direction.
4. Ignore Time: Only plot based on price movements and ignore time periods entirely.

Example:

Suppose we have a stock starting at $100, with a box size of $1 and a 3-box reversal. If the price moves to $104, we will plot four X’s. If the price then falls to $101, it will not trigger a new column because it hasn’t moved by 3 boxes in the opposite direction. If the price falls to $100, it will trigger the reversal and we’ll start plotting O’s in the next column.

Interpretation of Point-and-Figure Charts

Identifying Trends:

• Uptrends: Recognizing consecutive columns of X’s extending higher.
• Downtrends: Recognizing consecutive columns of O’s extending lower.
• Trend Reversals: Occur when a new column in the opposite direction is created, indicating either new buying or selling momentum.

Support and Resistance Levels:

Because P&F charts simplify price data by filtering out insignificant price movements and focusing on the essential trend, they can highlight support and resistance levels more clearly than time-based charts. Areas where columns consistently reverse can be indicative of support or resistance.

Advantages of P&F Charts

1. Clear Trends: Because they filter out minor price fluctuations, P&F charts make it easier to identify major trends.
2. Objective Buy and Sell Signals: The clear rules for box sizes and reversal amounts help in setting objective trading signals.
3. Reduced Noise: By focusing solely on price, P&F charts eliminate time-related noise, which can often distort trend analysis.
4. Portfolio Management: They allow better identification of long-term investment trends rather than short-term price movements.

Applications in Algo-Trading and FinTech

Algorithmic Strategy Development:

P&F charts can be integrated into algorithmic trading strategies where trend-following logic is essential. By automating the box and reversal criteria, algorithms can execute trades in a systematic manner when specific P&F patterns emerge.

FinTech Platforms:

Companies in the financial technology space utilize P&F charts for various applications. Platforms providing trading signals and analytics tools can incorporate P&F charts to offer users a different perspective on market movements, aiding their decision-making process.

Example Companies:

• TradingView: A popular online platform that supports P&F charting. Users can create and customize P&F charts based on their preferred parameters. TradingView
• MetaStock: Software solutions like MetaStock also offer functionalities to create P&F charts and incorporate those into broader market analysis. MetaStock

Limitations of Point-and-Figure Charts

While P&F charts provide several advantages, they also come with limitations:

1. Complexity in Volatile Markets: In highly volatile markets, the frequent reversals can make P&F charts less actionable.
2. Historical Sensitivity: As with many technical analysis tools, P&F charts are based on historical price movements and may not always accurately predict future trends.
3. Absence of Time Factor: While the removal of the time element helps in focusing on price changes, it also means these charts can miss out on time-based analysis, which can be crucial in certain trading strategies.

Conclusion

Point-and-Figure charts offer a unique and beneficial perspective in financial charting, particularly for identifying long-term trends and support/resistance levels. Their utility in algorithmic trading and FinTech makes them relevant for both individual traders and financial institutions. However, their limitations in certain market conditions and the absence of time-related data should be mindful considerations when integrating P&F charts into trading strategies.