Point and Figure Charts
In this section, we will learn 'Congestion analysis.' This congestion occurs when the price is relatively stable or moving sideways.
The importance of Point and Figure charts is enhanced by the width of any pattern. Congestion areas tend to occur after a strong advance or decline. It is the time that profits are taken and positions are reversed after the rise or decline into the area, and it is a time for adjusting to the new price level after the strong move.
Congestion is a good time to take new positions as well, provided that there is sufficient evidence as to the future direction. We need to have an idea as to the direction its going to break into before we take a position. The key to congestion analysis is to identify whether accumulation or distribution is taking place. Accumulation and distribution are identified by where the majority of the price action is taking place. Activity towards the bottom of a congestion area indicates strong support and the probability that the breakout may be from the upside. The reason is that if there is activity towards the bottom of the range - lots of small column changes - it shows buyers using every opportunity to open new positions.
Conversely, activity towards the top side of the pattern indicates strong resistance and that the break from the pattern will be to the downside. This activity shows profit taking, because sellers are taking every opportunity to close their positions or, indeed, open short positions.
Congestion patterns are simply just a combination of the basic Point and Figure patterns discussed so far.
Signals with the trend or against the trend
Point and Figure signals start with double-tops and bottoms in 3-box charts and with semi-catapults in 1 -box charts. These are weaker than triple-tops and bottoms, but many double-tops and bottoms are good reliable signals.
In a strong downtrend, for example, double-bottom sell signals would be much more reliable than double-top buy signals. Each cell can be taken but a double-top buy should be dealt properly, until there is more evidence of a trend reversal.
The above figure shows the price in a strong downtrend. Each double-bottom sell signal is good for acting on. However, the double-top buy signal should be used only for closing out short positions and not for going long until more price movement confirms the end of the downtrend.
You can dramatically improve your success rate just by taking clear signals with the prevailing trend.
The opposite is true for a strong up trend, where double-top buys can be relied on and double bottom sells are treated with suspicion unless and until there is a strong reversal.