Key to stock market profits?
Looking for the holy grail
For many years wonks have looked for patterns in the stock market. They theorize that patterns that have repeatedly in the past preceded an up or down move should do the same thing again. These signals can be used to predict stock market or individual stock movements and ideally give an investor a strong signal when to buy and when to sell.
Over the years, researchers have used technical analysis (using charts of price movements and other statistics) to search for a method to chart patterns and then analyze them with the objective of using them for investing. They came up with many kinds of charts, for example, candlestick, bar, and line charts.
Traditional charts (like those mentioned above) simply plot price movement on the vertical axis and time on the horizontal axis. A single chart can contain multiple lines, such as a 7-day moving average of the price along with a 28-day moving average. The signal to buy or sell could be when one price line crosses another. Charters may develop more complex charts and more complicated buy and sell signals. For example, also keeping track of daily volume might be used as another indicator of a coming price move.
About 125 years ago, point and figure charts were conceived.
Point and figure (p & f) charts
Point and figure charts also attempt to predict when stocks will start a profitable up or down move. Another way to look at this is: when has an uptrend stopped and a significant downtrend has begun (or vice versa). The distinctive feature of a p & f chart is that time is not a factor. Time is not plotted on the horizontal (x-) axis nor is it considered in any way.
The object is to see price trends clearly no matter how long they take to develop. After all, some predictors may develop in a day or two, while others may take weeks or months to show themselves.
A typical p & f chart shows columns of Xs and Os side by side in an alternating fashion. Xs, indicate that price is going up, and Os represent a downward movement of price. In addition to leaving time out, insignificant price movements are also ignored, as explained below.
Making a p&f chart
First, the chart maker must decide on an acceptable unit of price. For a low-priced stock, it might be only one dollar; for a higher priced stock, it might be twenty dollars. If the closing price does not move at least one unit from closing price the day before, it is judged insignificant, and no entry is made on the chart. If the closing stock price was three units higher than the previous close, then three vertical Xs would be entered on the chart. If the closing price fell one or more units, an appropriate number of Os would be entered in a similar fashion. Any time the price reverses direction, a new column is started.
That’s the general idea of plotting a chart. There are many sources on the internet that can instruct users on the details.
Using p & f charts
Making the charts is the easy part. Using and analyzing trends is much more difficult.
After constructing a p & f chart, the question is how to use and interpret what it’s showing. P & f experts claim the chart shows the law of supply and demand at work, and that law is what determines the price of a stock. If there are three or more X’s in a column, demand is in charge and has overcome supply. The reverse is also true. When the chart produces three O’s in a column, this indicates supply has overcome demand. To the experts, p & f charts show the establishment of trends, trend reversals, and the supply and demand of charted issues or the market as a whole.
Spotting a major trend reversal
There is a lot of back and forth (noise) before a major trend reversal takes place. Think of this as analogous to the motion of waves. The overall trend of the tide may be incoming, but each wave washes up on the beach and then retreats. The next wave comes up a little bit further, then retreats, and so on. After a while, the reverse process takes place. Each succeeding wave comes in a little further back on the beach. Either way, the overall movement is in one direction, but it happens in stages with reversals of the major trend in between. P & f charts attempt to clearly show the major trend reversals without the noise of the small intermediate movements.
The simplest indicator (and therefore not very accurate) of a trend reversal is when the current column of Xs is higher than the top of the last column of Xs. It’s recommended this should be used in conjunction with other indicators since it’s not reliable all by itself. Also, the experts warn that this indicator is very useful for short-term trend reversals but not so good for major reversals.
There are many more signals that p & f chartists use to anticipate price reversals of a single stock or of the market as a whole. Many books and websites offer help in this area.
This is only one method of predicting; there are many more. And remember, success is not guaranteed with any method.