Point and Figure Charts
Point And Figure’s Contribution To Market Breadth
There are many indicators that measure breadth in different ways, but the thinking behind all of them is the same.
The advance decline line is one of the most popular. It calculates the number of shares that have advanced on the day and the number that have declined. The difference between the advances and declines is added to or subtracted from a running total, which is then plotted.
Advance decline lines are drawn as line charts, but they can of course be drawn as Point and Figure charts. As they are not based on Point and Figure, however, they have no place in a book on Point and Figure charts. There is, in fact, only one breadth indicator that is purely Point and Figure and that is bullish percent, discussed below.
The point of breadth indicators is that they are an independent measure of the market or sector index. For example, if, on a day when all shares in Nifty fell or remained unchanged, one of the biggest shares in the index rose by 5%, the index itself would rise. Would that index rise be a true reflection of the market for that day? It would, in fact, be misleading. Market breadth, on the other hand, would count 99 shares down or unchanged and only 1 share up, giving a strong downward bias on the day. It brings another dimension to the analysis of indices and markets.
Point and Figure charts are either bullish or bearish - that is a major advantage of them that they give a clear picture. A bullish Point and Figure chart is one where the last signal generated was at least a double-top buy signal.
To construct a bullish percent chart we will have to draw a Point and Figure chart of every share in the index we wish to study, on the day you wish to study it. We then have to count the number of shares that have, as the last signal, at least a double-top buy. The number is then expressed as a percentage of the total number of shares in the index. The resultant percentage is then used as the next data point to construct another chart, which is the bullish percent chart. The next day, the whole procedure is repeated, making the creation and maintenance of any breadth indicator a tedious task.
The more common Point and Figure version of bullish percent cannot be lined up with the price chart but it has two advantages: firstly, normal Point and Figure double-top and bottom signals apply; and secondly, the last column tells you the status of the market. A rising column of Xs means the market is bullish and is continuing to be so. A falling column of 0s means the market is bearish because an increasing number of shares are turning bearish.
- A.W. Cohen, the originator of bullish percent, only used the Point and Figure version and never the line chart. His rules for reading it were simple:
- A rising column of X below 50% is a bull alert signal.
- When the column of X crosses above the 50% level, the bull trend is confirmed.
- However, if the column of Xs is below 50% and issues a double-top buy then the bull trend is confirmed earlier.
- A falling column of 0s above 50% is a bear alert signal.
- When the column of 0s crosses below the 50% level, the bear trend is confirmed.
- However, if the column of 0s is above 50% and issues a double-bottom sell then the bear trend is confirmed earlier.
- He added that any turn up from below 10% is a signal for a new bull market.
Analysing bullish percent as a line chart
A line chart of bullish percent is not used often, but it should not be ignored because it can show things that the Point and Figure version does not. The main reason it is used is that it can be plotted below the index itself and thus compared on a day-to-day basis. We have to remember that although a line chart is plotted, the foundation of the indicator is still in Point and Figure because it uses the percentage of bullish Point and Figure charts each day throughout the entire history.
- The bullish percent Chart should be constructed as follows:
- Each day, total the number of shares that display a bullish pattern (last signal a double top buy).
- Express that number as a percentage of the total number of shares of Nifty Index.
- Plot the bullish percentage each day.
The bullish percent line chart can be regarded and analysed as if it is an overbought/oversold oscillator, where anything above 70% is considered overbought and anything below 30% is considered oversold.
A break below 70% is not a sell signal. 'Overbought' itself is not a sell signal, just as 'oversold' is not a buy signal. Strong uptrends can stay overbought for months, even years. Provided the bullish percent remains above 70%, the uptrend in the underlying index is strong and intact. It means that 70% of its constituents have bullish Point and Figure charts.
A break below 70% shows a slowing down and perhaps a weakness in the uptrend, but does not signal that the uptrend is at an end. It just indicates that trends cannot accelerate forever; they need a period where the speed of the rise is constant or even slowing. A break below 70%, therefore, simply tells you that some of the overbought nature has been relieved by some shares turning bearish - most likely the overextended ones. So they indicate the trend has slowed down rather than reversed.
Because of their very nature, indices tend to remain overbought much longer than they remain oversold. Therefore, dips below the 30% level into oversold territory are usually short-lived, and a break back above the 30% level is a strong new bullish signal. It means that only 30% of stocks have bullish patterns but that number is increasing. The fact that it is increasing means that more charts are becoming bullish and less are turning bearish.
It is the 50% line, however, that is the real indicator of trend change. A break above 50% indicates a change to a bull trend and a break below 50% indicates a change to a bear trend. It would, however, be wrong to assume that trends change at the 'flick of a switch' and so sticking rigidly to the 50% level as the indication of a trend change is unwise. It is better to draw a 2.5% band either side of the 50% level and regard the crossing of the band edges as the signal. If the bullish percent falls to the band and bounces back towards the 70% level, it is a reinforcement of the uptrend in the index.
The area between 70% and 30% is the trend change area. If the bullish percent oscillates above and below the 50% band without ever reaching 70% or 30%, this indicates uncertainty about the prevailing trend, suggesting that it is ending and is in the process of being replaced by a trend in the opposite direction after a period of sideways movement. At this time, positions in the market are best avoided until the trend becomes clear again.
The strongest trend change signal that bullish percent can give is when it breaks below 70%, then goes on to break below the 50% and then the 30% level without much interruption. It is a clear signal that a bull trend has ended and we need to be cautious. The reason is that there is a steady decrease in bullish Point and Figure charts and consequently increase in bearish ones. To turn a bullish chart bearish requires a double-top buy signal to be reversed into a double-bottom sell signal.