How to Trade Point and Figure Charts

Developed in the early days of trading, point and figure charts track only price—not the passage of time—thus allowing traders to better follow trends in the markets and not be scared away by minor corrections.

Long before we had computers to chart price, traders were making a living and doing it by watching price movement. One of the earliest types of charts was called a point and figure chart (P&F). It started from traders who would tick off prices as they watched the trading. Eventually, the ticks changed to X’s and O’s to note movement in price and even see trends.

Today, many chartists have switched to candlestick charting to make their decisions to buy or sell. A drawback to this style of charting is that many people are prone to exiting early from profitable trades when they see small pullbacks or corrections.

An advantage of point and figure charting is that it allows the trader to see the trend and stay in it even through minor corrections. For this advantage, we may sacrifice some profits with a larger stop, but with the larger profit potential, it may be worth it.

Another interesting feature of point and figure charts is that it does not take time into account when charting. On a candlestick chart, you will have a candle for every period. For instance, on a five-minute chart, you would have a candle every five minutes whether the price moved or not. In a P&F chart, a new notation is made only when price moves by a certain amount. If there is no trading, or if price does not move enough, no notation is made.

To create the chart, you will use an "X" to note when prices rise by a certain amount and an "O" when they decline by an amount. You only put either X’s or O’s in a column.

If you need O’s due to a reversal in price, you would start a new column. You do not put X’s and O’s in the same column.

You must first decide the minimum amount of movement to note. ! This is referred to as the box size. You can set the box size for anything you would like, but remember the smaller the size, the more sensitive the chart will be.

This may be good for short-term traders, but it can cause you to overreact to slight corrections. As a rule of thumb, you should set the box size at about 1% of price. You could use 2% when charting the indexes like the S&P 500 and the Nasdaq, however.

You also need to decide the reversal setting. This will be the multiple of the box size that would create a reversal signal.

For instance, if you set the box size at $1, a 1x1 chart would change from a column of X’s to a column of O’s when price reversed by $1. On a 1x3 chart, you would continue to mark X’s for the upward movements until you have price reverse by at least $3 ($1x3). Once that happens, you would start a column of O’s to the right of the previous column.

The larger reversal size will filter out many small corrections that might have otherwise scared traders out of positions.