Point & Figure Charting By DAQ Copyright 2002 AWP Financial Group All Rights Reserved This version is offered for private use only. Download and printing rights for personal, private use permitted. Reproduction or retransmission of any kind prohibited without express written consent of AWP Financial Group Please note: Information contained on this website and within all related works is provided by research featured herein. Materials and information presented do not and cannot, guarantee profitable trading and any decision to trade based upon the information provided herein is the responsibility of the person authorizing the transaction. These educators and their materials are provided for informational purposes only and there is always a risk of substantial loss when trading futures and options. Past performance is not indicative of future results. Please consult with a licensed professional for all financial decisions. Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not actually been executed, the results may have under- or over-compensated for the impact, if any, of certain market factors such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. FORWARD Welcome to the world of point and figure charting! You may have heard of the method from a friend, or possibly have seen the charts created using Xs and Os in these pages. Chances are, however, that you haven't heard much about point and figure charting from your broker, or even from the financial media. That's because point and figure charting is a lost art in these days of myriad technical indicators and black boxes. Point and figure charting is a way to measure and observe the rudimentary forces that determine the price of an asset: Supply and Demand. These two forces are too often forgotten in today's technologically advanced trading environment. It's the aim of point

and figure charting to simplify, in an objective fashion, the investment process through monitoring supply and demand. History Charles Dow created the point and figure charting method in the 1800s, when he was looking for a method to organize stock price fluctuations. Over the years, the method attracted the attention of investors who began studying the patterns that stocks formed over time. What these investors found was that many patterns repeated again and again. Through recognition of the patterns on the charts, investors began to anticipate ahead of time movements in stock prices based on experience from past patterns. Point and figure charting has gone in and out of fashion since Charles Dow first started notching Xs and Os on a sheet of graph paper. Today, the method is more widely used among institutional investors for managing risk, which makes it even more appealing for individual investors following big money. There is a limited amount of educational material on point and figure charting despite its effectiveness. One of the better books in publication is Tom Dorsey's Point & Figure Charting. Supply & Demand In the end, an asset's price is determined by supply and demand, which is the basic premise of point and figure charting. If there are more buyers willing to buy than sellers willing to sell, then the price of an asset will increase. Conversely, more sellers and fewer buyers will result in a lower price for an asset. The point and figure method is concerned with only the price fluctuation of an asset. Volume is not taken into consideration. Time, on the other hand, is tracked with less emphasis than on a bar chart, for instance. But the main focus is price and its movement. Creating Charts Point and figure charts are created using columns of Xs and Os. The Xs denote when demand is outstripping supply. In other words, rising prices are denoted by a column of Xs. Supply is denoted with Os. That is, when an asset price is decreasing, supply is said to be overwhelming demand, in which case prices are falling. The primary benefit of the method comes from how price moves from demand to supply, and back again. In the process of reversing from Xs to Os, patterns begin to emerge in price, which can be used to plan trades. In order for price to reverse from a column of Xs to a column of Os, for

example, the asset will need to move in the opposite direction of the last column on the order of 3 boxes. The 3-box reversal method is the most widely used when creating point and figure charts, although that number is not set in stone. Different reversals can be used, but for our purposes, we'll use the 3-box reversal. The size of the box used on the point and figure chart will depend on the price of an asset. The following table displays the typical box sizes for a range of prices. Most stocks, for instance, trade within a $1 box size. While indexes and major averages typically trade within much larger box sizes, such as 5 points per box.

Once you determine the box size for the asset you're tracking, you can then begin to create a point and figure chart based on the fluctuations in price for the asset. Fortunately there are several free Web sites and charting programs that create point and figure charts for you. But many old school chartists still update charts by hand. The following diagram displays a typical 3 box reversal, in which the asset has reversed from its last column on the order of three boxes several times. Keeping in mind that when the asset is in a column of Xs it is said that demand is in control; that is, prices are rising. Conversely, the Os denote when supply is in control, when prices are falling. 24 X X 23 X O X O 22 X O X O 21 X O O 20 X When updating the charts for the day, the first question to ask is what column is the asset currently in. If the asset is in a column of Os like the diagram above, then the next O in the column would come only on

a trade to 20. If the asset didn't trade 20 during the day, then the next question to ask is if the asset reversed higher by 3 boxes, which would put this particular chart back up to 24. If neither 20 nor 24 were hit during the day, then the chart stays in its current pattern until one of those two prices are hit. Summary Understanding how a stock reverses from a column of Xs to a column of Os is the first step to understanding the point and figure method. Luckily, that's about the most sophisticated aspect of the method. Its ease of understanding is another benefit of the point and figure method. In the coming weeks, we'll explore other concepts, such as application through pattern recognition. In the meantime, happy charting!

Short-Term Trading Using Bullish Percent Measuring and managing market risk are the two most important aspects of successful trading. But that very simple fact is too often lost in the maze of technical indicators along the path to forecasting market direction. Technical tools such as Stochastics, MACD, and ADX, despite their fancy names and formulae, each in their own unique way relay the amount of risk in any given market at any given time. But sometimes the signals cause more confusion than clarity about the risk set-up at the hard right edge of the chart. The most successful institutional and individual investors consider risk first before entering a position; forecasting direction is an afterthought. One of the greatest investors of all-time, Warren Buffett, once offered, �An investor needs to do very few things right as long as he or she avoids big mistakes.� The notion of considering risk first -avoiding big mistakes - is contradictory to conventional trading wisdom, which places the emphasis on forecasting direction. It is the aim of the bullish percent indicator to measure market risk in the here and now; it identifies the path of least resistance. By identifying that path, a trader, in turn, is essentially forecasting market direction, but not in a speculative manner. Rather, the bullish percent indicator implies market direction by first measuring market risk. Background It was with the aim of measuring risk in a group of stocks with which the bullish percent indicator was born. In 1955, A.W. Cohen developed the tool for measuring risk at market bottoms and tops.

Like many investors of the time, Cohen observed that the chart signals were incorrectly bullish near market tops and, conversely, incorrectly bearish near market bottoms. What Cohen observed nearly 50 years ago was that buying exhausted near tops because everyone who was going to buy had already done so. And just the inverse applied to traders� actions near bottoms. To combat the dilemma, Cohen devised the bullish percent indicator that is contrary in nature. That is to say, the indicator goes against the masses near tops and bottoms, where the crowd is normally wrong. As the indicator evolved, with much help from Tom Dorsey of Dorsey, Wright & Associates, it began to reveal increasing amounts of information about the risk/reward dynamics of markets in the present. Mechanics The bullish percent indicator is a collection of stocks, such as a major market average or sector index, which compares the number of stocks on buy signals versus sell signals. Readers unfamiliar with the point and figure methodology need only consider a stock on a buy signal as one being bullish, and a stock on a sell signal as one being bearish. Each stock within a given market counts for only one basis point to the bullish percent indicator, it does not take into account share price or market capitalization, only whether the stock is on a buy or sell signal. It is the nature of the underlying stocks, oscillating from buy to sell signals, from which the risk for an index is extrapolated. It is important to note here that the bullish percent indicator is only applied to stock indices. Some of the more commonly used bullish percent measures include the NYSE Composite, S&P 500, and Nasdaq-100. The latter two obviously are of concern to futures traders. But the bullish percent indicator can be applied to any group of stocks for which a futures contract trades, including the Russell 2000, Dow Jones Industrial Average, and Nikkei 225. Absolute Levels: 30 & 70 The absolute level of the indicator reveals the position of risk in any given group of stocks, similar to Stochastics. Put another way, bullish percent levels act as an oscillator, measuring overbought, oversold, and in between. The indicator can go only as high as 100 percent, revealing that all stocks in the index are on buy signals (bullish), and it can only go as low as zero, revealing that all stocks are on sell signals (bearish). Rarely does an index reach such extreme readings, but

these are the parameters that define the range of bullish percent readings. The oversold reading comes at or below the 30 percent threshold. Think of the bullish percent reading below 30 percent as a Stochastics reading buried in oversold, below 20. A bullish percent reading at or below 30 reveals that the market is oversold; it tells a trader that selling is reaching an exhausted level; it reveals that 30 percent or less of the stocks in a given market are bullish. The overbought reading comes at or above the 70 percent threshold. Again using Stochastics as a reference, a bullish percent reading above 70 is similar to a Stochastics reading above 80. A bullish percent reading above 70 reveals that 70 percent or more of the stocks in a given market are bullish. At or above 70 percent, a market is saturated with buying. The Nasdaq-100 is a good futures-based index to use as a visual study because the index has 100 components, so each stock accounts for exactly 1 percent of the bullish percent. The chart below will help to better depict what overbought and oversold looks like. Nasdaq-100 Bullish Percent: Overbought & Oversold

A red line denotes the overbought level of 70 percent or greater because an overbought market is bearish due to the greater downside risk than potential upside. Think of it this way: If a market is at 70 percent, only 30 percent more of the stocks can go from bearish to bullish before reaching the maximum level of bullishness at 100 percent. Now think backwards from a risk perspective. At 70 percent or higher, there�s more risk to the downside than upside potential because of the amount of buying that has already taken place. So who�s left to buy that already hasn�t? At the other end of the spectrum, a green line denotes the oversold reading of 30 percent or less because an oversold market holds

greater upside potential than downside risk. At or below 30 percent is near the maximum level of bearishness of zero percent, and is precisely the time at which the crowd turns tail and sells. As the chart displays, the bullish percent indicator is a mean-reverting indicator, meaning that it infrequently spends its time outside of the oversold and overbought extremes. Most of its time is spent somewhere between the 30 and 70 extremes. This observation should help to reinforce that going against the crowd near market bottoms and tops is an intelligent bet. Relative Levels: Confirmed Or Correction? There are six positions of bullish percent, three bullish and three bearish, which will take us to the next step of application to short-term futures trading. But before we get into the specific positions, it�s important to observe how bullish percent reverses from one column to the next. Like a standard point and figure chart, the bullish percent chart reverses from one column to the next based upon the 3-box reversal method. For readers unfamiliar with the 3-box reversal, simply consider that for a bullish percent column to reverse from Xs to Os it needs to reverse by six percent from the previous relative high or low; six percent because bullish percent charts are plotted using a two percent box. (A column of Xs denotes that bullish percent is increasing, while a column of Os denotes that bullish percent is decreasing.) One final note before we get to the specific application. It�s important to remember to think of the market, and its risks, from both sides at all times. The risk for a bear is opposite from a bull, and both sides feed off one another. The bullish percent indicator is most effective when observed from both a bullish and bearish perspective. Bull Alert � The bull alert position is achieved when the indicator reverses into a column of Xs from below the 30 percent oversold level. This is the early stages of a bull market just coming out of an oversold condition. At this point in the progression of risk, most stocks are trading near lows, and most selling has exhausted, clearing the way for greater upside potential. Therefore, the risk dynamic has shifted to the upside in bull alert, but it hasn�t yet been confirmed. Many times the bullish percent will reverse into a column of Xs below the 30 percent oversold threshold, only to slip back down to retest lows for the final washout of weak hands. For this reason, traders shouldn�t be aggressively bullish in a bull alert market. Rather, the

bears should grow more conservative in terms of upside risk management and downside potential, while the bulls should start looking at taking positions near support. In the bull alert market, short covering and relief rallies are typically observed. Nasdaq-100 Bullish Percent: Bull Alert

Bull Confirmed � This is the strongest bullish position of the indicator. It is achieved when the bullish percent exceeds a previous high on the chart. The bull confirmed market is one in which traders should play aggressively to the upside because that�s the path of least

resistance. The greatest amount of risk in the market lies to the upside, so it makes sense to trade in that direction. But the absolute level of the bull confirmed positioning needs to be addressed, using the overbought/oversold extremes outlined above. A bull confirmed market below 50 percent is much more bullish than one above 70 percent. That�s because there�s less upside potential above 70 percent, and more downside risk. As a general rule, a bull confirmed market at 50 percent, plus or minus 10 percent, is one in which traders should be aggressively bullish. That includes pursuing intraday breakouts, and brief pullbacks to support. Nasdaq-100 Bullish Percent: Bull Confirmed

Bull Correction � The bull correction mode reveals a bull market that is getting tired, one that has run out of steam in the short-term. The bull correction status happens when the bullish percent reverses lower by six percent below the 70 percent overbought threshold, from a bull confirmed position. As long as the indicator reverses below the 70 percent level from bull confirmed, then the bull market is likely to resume. For practical application, the bull correction market is one in which to look for long trades near intraday support, or half position short trades near intraday resistance. Risk is still positioned to the

upside, and for that reason bullish trades should dominate trade selection. Although small bearish positions can still be effective. Nasdaq-100 Bullish Percent: Bull Correction

Bear Alert � The bear alert market is reached when the bullish percent reverses into a column of Os from above the 70 percent overbought level. This is a market that has grown overbought, and that is beginning to show signs of internal weakness. As such, traders should look for shorting opportunities near intraday resistance in a bear alert market, and be very careful about establishing long positions. The risk in a bear alert market is to the downside. And like the bull alert market, the bear alert market will typically try to retest relative highs

before breaking down, which is why bearish trades near intraday resistance are so successful. To a lesser extent, breakdowns can be tried in a bear alert market. Nasdaq-100 Bullish Percent: Bear Alert

Bear Confirmed � The bear confirmed market is the strongest of bearish markets. It is reached when the bullish percent indicator takes out its previous column of Os. This is a market in which traders should look to aggressively enter short positions, and hold onto for greater potential downside. A bear confirmed market is one in which breakdowns below support typically work very well, and short entries

near intraday resistance hold very little upside risk because the overall paradigm has shifted decidedly to the downside. The absolute level of the indicator, however, should be heeded. Aggressively shorting breakdowns in a grossly oversold market below the 30 percent oversold threshold may not be the best approach. You wouldn�t want to press bearish positions below a 30 percent bullish percent reading for the same reasons you wouldn�t press a short when weekly and daily Stochastics are buried in oversold. As a general rule, a bear confirmed market at 50 percent, plus or minus ten percent, is one that should be aggressively shorted. Nasdaq-100 Bullish Percent: Bear Confirmed

Bear Correction � A bear correction market indicates a pause in a bearish market, it�s one in which relief rallies and relatively smaller short covering rallies normally take place. Trying bullish positions near support using tight stops is acceptable, but breakouts typically fail in the bear correction. Furthermore, breakdowns are typically met with buying by shorts covering because there is a slight shift in risk to the upside due to the correction of the bear confirmed status. Like the bull correction, a bear correction is a market in which implementing smaller traders and using tighter risk management makes fiscal sense. Nasdaq-100 Bullish Percent: Bear Correction

Summary The bullish percent indicator doesn�t reverse every day. In fact the charts above span about a year. It�s a slower indicator, and actually was designed for more of an intermediate-term outlook. But it�s very adaptable to short-term trading, including day trading. The biggest benefit of using the bullish percent comes from its help in establishing a working market bias in the present. The indicator measures where risk lies in the market, and that simple revelation will help keep you on the right side of the market more often that not.

Forecasting market direction is the most difficult aspect of successful trading. Identifying risk first, working backwards in the equation of the market, will help a trader to achieve the same end, just through a different means. By establishing the path of least resistance, the bullish percent does in fact forecast short-term direction. The six different conditions of bullish percent can be incorporated into an already-established trading methodology, using the positions as a top-down view of the market profile. In fact combining the broad view that the bullish percent provides with fine-tuned indicators can increase odds of success even further. Like anything else, the tool takes time to learn all of its nuances, its advantages and uses. It�s worked for me so far, and I think it can work for you too. Good Luck! DAQ