Point & Figure Indicators
Though we have learned different technical indicators in our earlier module - Technical indicators, we use slightly different technical indicators in the case of point & figure charts. Let us explain how?
Point and Figure charts should not be drawn of any smoothed indicator. Indicators that are smoothed by using any or other averaging technique means the resultant Point and Figure chart will not be of much use. MACD18 and slow stochastic19 are examples of smoothed indicators. That leaves three types of indicator which can be drawn using the Point and Figure method.
Relative strength 20 against another instrument
Cumulative lines such as on-balance volume.
Oscillators such as RSI and momentum.
Point and Figure of relative strength
Relative strength shows relative performance, not absolute performance. A rising relative strength trend does not mean that the stock (numerator) is rising, it simply means that the stock is performing better than the index (denominator). It could mean that the stock is falling but not by as much as the index; or it could mean that the stock is trading sideways but the index is falling; or it could mean that they are both rising but the stock is rising more than the index. The converse applies with a falling relative strength trend. It shows the rise and fall as compared to the underlying index.
When drawing Point and Figure charts of relative strength, scaling becomes an issue because relative strength is a ratio of the price of one instrument to the price of another and therefore has very small or very large numbers. The preferred method, therefore, is to normalise the relative strength data before plotting the chart, by dividing each relative strength value by the first relative strength value in the series and then multiplying by 100. This makes construction easier and has the additional benefit that all relative strength charts become directly comparable.
Using Point and Figure counts on relative strength charts
Point and Figure counts can be used on Point and Figure charts of relative strength, but remember the numbers don't really mean anything. It is the level that you are looking for. Counts are potential targets, the achievement or non-achievement of which gives you more information about the quality of the trend.
Point and Figure of on-balance volume
Point and Figure charts don't show volume but volume may be incorporated by drawing Point and Figure charts of on-balance volume (OBV). It lends itself to the Point and Figure representation because it is a cumulative line where the values that are used to construct the line have no meaning.
As with relative strength, the main analysis of OBV is the trend. A rising trend in an OBV chart indicates accumulation, whereas a falling trend indicates distribution. OBV shows the presence of informed buyers and sellers. It can show accumulation taking place prior to a price rise and distribution prior to a price fall. The rationale behind it is that high volume combined with a price move indicates powerful informed investors taking positions. For this reason, it can show the presence of trading on sensitive information.
The biggest problem with Point and Figure of OBV is that it can have large values, depending on the volume of the share in question.
Point and Figure of oscillators
In theory any oscillator may be drawn as a Point and Figure chart. As stated earlier, smoothed oscillators such as MACD should, however, be avoided, as the lack of minor trend changes results in long columns of Xs and 0s which render the Point and Figure chart useless. Remember, Point and Figure charts thrive on reversals.
Oscillators such as momentum, overbought/oversold, commodity channel Index and RSI do work well in Point and Figure format, but there is, in fact, no limit to the indicators that can be drawn using Point and Figure charts rather than line charts.
- Point and Figure is a method for representing any series of numbers. Most often those are prices, but Point and Figure charts can also be drawn of any calculated line which can then be subjected to all the power of Point and Figure analysis.
- Smoothed indicators should be avoided because Point and Figure thrives on volatility.
- The most common indicator to be represented as a Point and Figure chart is relative strength.
- Point and Figure works well with any cumulative line, such as OBV.
- Oscillators which are not smoothed also benefit from Point and Figure representation.
- Point and Figure counts can be used to calculate targets for the indicator, although they do not work with fixed scale indicators. The value of the count used on indicators is not important, rather it is the level that the count projects.