Point and Figure Charts explained
A point-and-figure chart is a graphical representation of price movements that ignore the passage of time. They are not as popular as other forms of charts used in technical analysis, but they can be useful in certain situations. They were first developed in the 1890s by a man named Charles Dow.
They are a series of X columns and O columns. The X's signify a price increase, while the O's represent a decrease. An X is added to the column every time the security's price increases by full box size. A new column is added when the security's price decreases by an equal or greater amount than the reversal size. Then, the first O in the new column is plotted 1 box below the last X of the previous column. A decline in price and a reversal to the upside follow the same rules. For example, a trader chooses a box size of 2 and a 3-box reversal (2x3 P&F chart). If the price continues to move up, X’s are added in a single column for every $2.00 increase in price. When the price declines by at least $6.00, the reversal is triggered and a new column of O’s is started with a first O plotted 1 box below the last X of the previous column.
The size of the box and the reversal can be chosen arbitrarily. Different box sizes provide different perspectives on the price movement of a security. The smaller the size, the greater detail of price fluctuations is shown, and the larger the size, the more short-term action is omitted and a big picture is illustrated. Reversal size follows the same logic and the most commonly used sizes are 1, 3, and 5.
Also, as was already mentioned Point and Figure charts do not take time into consideration and only plot price movements that follow the rules described earlier. Thus, it could take any period for a new box to be plotted (e.g. hours, days, weeks). A greater amount of plotting may be needed when there is an active market period and less plotting will occur in a quiet market.
The most significant advantage of point-and-figure charts is that they help determine critical support and resistance levels since they focus on the number of price swings that occur in a particular congestion space. And while volume is not explicitly shown on the point-and-figure chart, it is not completely lost. Intraday point-and-figure charts record all price change activity, the heavier or lighter volume are reflected in the number of price changes recorded on the chart. And since volume is one of the most important elements in determining support and resistance levels' strength, point-and-figure charts become especially useful when examining at which price levels the most trading takes place.
As we can see from the explanations and examples, point-and-figure charts are very useful in stock market trading. They help traders to identify changes in price trends that may indicate reversals or continuation of those trends.