Point and Figure Primer Part 2
Thursday, March 26, 2009 | Bob De DeaToday we're going to dig a little deeper and look at buy and sell signals, support and resistance, and bagels and lox. (Just wanted to see if you were paying attention!)
P&F charts are excellent for determining support and resistance levels. Turning once again to the chart for DKA:
I've identified in blue horizontal lines the price support points (designated by a line drawn between at least two O's at the same price range at the bottom of a column), and in red horizontal lines the resistance points (designated by a line drawn between at least two X's at the same price range at the top of a column). On the close price P&F there isn't an established resistance at the top left of the chart, but in September '08 there was a test of the support level between $29 and $30, and it failed to hold. DKA broke below $19.50, rallied to between $22 and $23, fell, then tested that level twice in November and December '08. By February, two support levels (around $17 and around $18.50) and two more resistance levels (around $20 and $21) were established.
In March of this year it busted through support to a new low. From here on out, if it rises above $18.50 we'll look for support there and the next resistance in the $20-21 range. (NOTE: Since there's only one box difference between the last two resistance levels, it is easier to think of them as one narrow band of resistance -- remember that each box represents a price range, and that charting is an interpretive art, not a black-and-white science.)
Pretty easy, huh?
Notice also that the DKA chart has built-in trend lines. The downward red line is the Bearish Resistance Line. The BRL has a counterpart in the Bullish Support Line. The BSL is an upward line drawn in blue. They provide an easy way to spot the long-term trend and can be used to determine entry and exit points, as well as stop-losses. Violation of either is usually significant. These lines are very helpful when implementing two strategies, the Bull Line Trade and the Bear Line Trade, which are detailed in the ETF Master Trader program (telling you any more would be unfair to members of the program but these strategies are very exciting ways to play a P&F trend).
One other thing you need to know about P&F charts: There are different patterns that, like candlestick charts, give you clues about the price action. Two of the simplest of these are the buy and sell signals. Briefly, a P&F buy signal occurs when a recent column of X's surpasses, by at least one box, the previous column of X's. A P&F sell signal occurs, conversely, when a recent column of O's descends below (ooh - sounds ominous!) the previous column of O's. A P&F chart is always on either a buy signal or a sell signal, and the signal doesn't change until the opposite signal kicks in.
I've marked the P&F buy and sell signals for DKA in the chart above.
1) First buy signal in October 2008 (blue circled "A" and blue up arrow).
2) Notice that the black circled "X" in May is not a new signal since it's still on the same buy signal from October (That is, a sell signal did not yet show up.)
3) In September 2008 we have our first sell signal (red circled "O" and red down arrow).
4) Notice that the black circled "O" in October is not a new signal since it's still on the same sell signal from September (That is, a buy signal did not yet show up.)
5) In December 2008 a column of X's tops the previous column, setting off a new P&F buy signal (next blue circled "X" and blue up arrow).
6) In January 2009 a column of O's bottoms out the previous column, setting off a new P&F sell signal (next red circled "O" and red down arrow).
7) And although we are now in a column of X's -- listen up here, this is important -- we are still on a P&F sell signal.
In this crazy market, these simple buy and sell signals don't necessarily mean much, so it's always important to study the history of a security, identify the current trend, and follow a plan.
Another cool thing about these charts is their flexibility. Before you experiment, however, I would encourage you to become accustomed to the traditional chart -- box size set to the scale in part one of this series, three-box reversal, etc. That way you have an informed idea about the changes you're making when playing around with the variables.
With that caveat, let's dig in.
When you change the box size, you change the whole picture. Here's the same chart with a box size of $2:
And the same again with a .5 box size:
Some difference, eh? Notice the two Bearish Resistance Lines and the Bullish Support Line in the second chart.
What we are doing here is making the chart more or less sensitive to price changes. I'm going to make this easy for you to see:
Increasing the box size reduces the noise.
Decreasing the box size amplifies the noise.
Why is this important? We need to know what we're looking at; the action helps identify the short- and intermediate-term trends within the long-term trend.
Another great tool is the ability to calculate the Average True Range for the underlying data used to build the chart. This takes into consideration the volatility of the security. In the case of DKA it translates to a box size of $.75:
Notice that, according to this scale, the security has not yet flipped to a column of X's. It's also no longer a logarithmic scale, where the box size changes based on price.
Now it looks like I've done it again and ran out of time and space, so I'll have to delay my discussion of the Bullish Percent Index till another time. BUT as a consolation, since the charts above are from last week, I want to tell you about the latest action on DKA.
March 17th was the day that DKA went on a Sector Hunter buy signal. As we've seen, it closed at $18.20 that day. On Monday the 23rd (the date of this writing), it was at $19.56 (a little over 7% increase in five days). I think this is yet another testament to the validity of the Sector Hunter signals, even in this market.
Till next week, happy hunting!
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Bob De Dea
Guest Contributor
The Tycoon Report
