PRICE PATTERNS
posted under
Philosophy of Technical Analysis
by ceecabolos
Pattern identification is also possible on point and figure charts. Figure 11.7 shows the most common types.
As you can see, they're not much different from ones already discussed on bar charting. Most of the patterns are variations on the double and triple tops and bottoms, head and shoulders, V's and inverted V's, and saucers. The term "fulcrum" shows up quite a bit in the point and figure literature. Essentially, the fulcrum is a well defined congestion area, occurring after a significant advance or decline, that forms an accumulation base or a distribution top. In a base, for example, the bottom of the area is subjected to repeated tests, interrupted by intermittent rally attempts. Very often, the fulcrum takes on the appearance of a double or triple bottom. The basing pattern is completed when a breakout (catapult) occurs over the top of the congestion area.
Those reversal patterns with the most pronounced horizontal ranges obviously lend themselves quite well to the taking of count measurements. The V base, in contrast, because of the absence of a significant horizontal price area, would not be amenable to the taking of a horizontal count. The blackened boxes in the chart examples in Figure 11.7 represent suggested buying and selling points. Notice that those entry points generally coincide with the retesting of support areas in a base or resistance areas in a top, breakout points, and the breaking of trendlines.
Trend Analysis and Trendlines
The price patterns in Figure 11.7 show trendlines drawn as part of those patterns. Trendline analysis on intraday charts is the same as that applied to bar charts. Up trendlines are drawn under successive lows and down trendlines are drawn over successive peaks. This is not true of the simplified point and figure chart, which we're going to study next. It utilizes 45 degree lines and plots them differently.
3 BOX REVERSAL POINT AND FIGURE CHARTING
In 1947, a book on point and figure was written by A.W. Cohen entitled, Stock Market Timing. The following year, when the Chartcraft Weekly Service was started, the book's name was changed to The Chartcraft Method of Point Sr Figure Trading. Several revised editions have been published since then to include commodities and options. In 1990, Michael Burke wrote The All New Guide to the Three-Point Reversal Method of Point Sr Figure Construction and Formations (Chartcraft, New Rochelle, NY).
The original 1 box reversal method of plotting markets required intraday prices. The 3 box reversal was a condensation of the 1 box and was meant for intermediate trend analysis. Cohen reasoned that because so few 3 box reversals occurred in stocks during the day that it was not necessary to use intraday prices to
construct the 3 box reversal chart. Hence the decision to use only the high and low prices, which were readily available in most financial newspapers. This modified technique, which is the basis of the Chartcraft service, greatly simplified point and figure charting and made it accessible to the average trader.
CONSTRUCTION OF THE 3 POINT REVERSAL CHART
The construction of the chart is relatively simple. First, the chart must be scaled in the same way as the intraday chart. A value must be assigned to each box. These tasks are performed for subscribers to the Chartcraft service because the charts are already constructed and the box values assigned. The chart shows a series of alternating columns with x's representing rising prices and the o columns showing falling prices. (See Figure 11.8.)
The actual plotting of the x's and o's requires only the high and low prices for the day. If the last column is an x column (showing rising prices), then look at the high price for the day. If the daily high permits the filling in of 1 or more x's, then fill in those boxes and stop. That's all you do for that day. Remember that the entire value of the box must be filled. Fractions or partial filling of the box don't count. Repeat the same process the next day, looking only at the high price. As long as prices continue to rise, permitting the plotting of at least one x, continue to fill in the boxes with x's, ignoring the low price.The day finally comes when the daily high price is not high enough to fill the next x box. At that point, look at the low price to determine if a 3 box reversal has occurred in the other direction. If so, move one column to the right, move down one box, and fill the next 3 boxes with o's to signify a new down column. Because you are now in a down column, the next day consult the low price to see if that column of o's can be continued. If one or more o's can be filled in, then do so. Only when the daily low does not permit the filling in of any more o's do you look at the daily high to see if a 3 box reversal has occurred to the upside. If so, move 1 column to the right and begin a new x column Chart Patterns
Figure 11.9 shows 16 price patterns most common to this type of point and figure chart-8 buy signals and 8 sell signals.
Let's take a look at the patterns. Since column 2, showing signals S-1 through S-8, is just a mirror image of column 1, we'll concentrate on the buy side. The first 2 signals, B-1 and B-2, are simple formations. All that is required for the simple bullish buy signal is 3 columns, with the second column of x's moving 1 box above the previous column of x's. B-2 is similar to B-1 with one minor difference—there are now 4 columns, with the bottom of the second column of o's higher than the first. B-1 shows a simple breakout through resistance. B-2 shows the same bullish breakout but with the added bullish feature of rising bottoms. B2 is a slightly stronger pattern than B-1 for that reason.
The third pattern (B-3), breakout of a triple top, begins the complex formations. Notice that the simple bullish buy signal is a part of each complex formation. Also, as we move down the page, these formations become increasingly stronger. The triple top breakout is stronger because there are 5 columns involved and 2 columns of x's have been penetrated. Remember that the wider the base, the greater the upside potential. The next pattern (B-4), ascending triple top, is stronger than B-3 because the tops and bottoms are both ascending. The spread triple top (B-5) is even stronger because there are 7 columns involved, and 3 columns of x's are exceeded.
The upside breakout above a bullish triangle (B-6) combines two signals. First, a simple buy signal must be present. Then the upper trendline must be cleared. (We'll cover the drawing of trendlines on these charts in the next section). Signal B-7, upside breakout above a bullish resistance line, is self-explanatory. Again, two things must be present. A buy signal must have already been given; and the upper channel line must be completely cleared. The final pattern, the upside breakout above a bearish resistance line (B-8), also requires two elements. A simple buy signal must be combined with a clearing of the down trendline. Of course, everything we've said regarding patterns B-1 through B-8 applies equally to patterns S-1 through S-8 except that, in the latter case, prices are headed down instead of up.
There is a difference between how these patterns are applied to commodity markets as opposed to common stocks. In general, all 16 signals can be used in stock market trading. However, because of the rapid movement so characteristic of the futures markets, the complex patterns are not as common in the commodity markets. Much greater emphasis is therefore placed on the simple signals. Many futures traders utilize the simple signals alone. If the trader chooses to wait for the more complex and stronger patterns, many profitable trading opportunities will be missed.
THE DRAWING OF TRENDLINES
In our discussion of intraday charts, it was pointed out that trend-lines were drawn in the conventional way. This is not the case on these 3 point reversal charts. Trendlines on these charts are drawn at 45 degree angles. Also, trendlines do not necessarily have to connect previous tops or bottoms.
The Basic Bullish Support Line and Bearish Resistance Line
These are your basic up and down trendlines. Because of the severe condensation on these charts, it would be impractical to try to connect rally tops or reaction lows. The 45 degree line is, therefore, used. In an uptrend, the bullish support line is drawn at a 45 degree angle upward to the right from under the lowest column of o's. As long as prices remain above that line, the major trend is considered to be bullish. In a downtrend, the bearish resistance line is drawn at a 45 degree angle downward to the right from the top of the highest column of x's. As long as prices remain below that down trendline, the trend is bearish. At times, those lines may have to be adjusted. For example, sometimes a correction in an uptrend breaks below the rising support line after which the uptrend resumes. In such cases, a new support line must be drawn at a 45 degree angle from the bottom of that reaction low. Sometimes a trend is so strong that the orig‑
111111U1111IMMIMIUMUMFigure 11.10 Examples of the Chartcraft three point reversal stock inal up trendline is simply too far away from the price action. In that case, a tighter trendline should be drawn in an attempt to arrive at a "best fitting" support line.
As you can see, they're not much different from ones already discussed on bar charting. Most of the patterns are variations on the double and triple tops and bottoms, head and shoulders, V's and inverted V's, and saucers. The term "fulcrum" shows up quite a bit in the point and figure literature. Essentially, the fulcrum is a well defined congestion area, occurring after a significant advance or decline, that forms an accumulation base or a distribution top. In a base, for example, the bottom of the area is subjected to repeated tests, interrupted by intermittent rally attempts. Very often, the fulcrum takes on the appearance of a double or triple bottom. The basing pattern is completed when a breakout (catapult) occurs over the top of the congestion area.
Those reversal patterns with the most pronounced horizontal ranges obviously lend themselves quite well to the taking of count measurements. The V base, in contrast, because of the absence of a significant horizontal price area, would not be amenable to the taking of a horizontal count. The blackened boxes in the chart examples in Figure 11.7 represent suggested buying and selling points. Notice that those entry points generally coincide with the retesting of support areas in a base or resistance areas in a top, breakout points, and the breaking of trendlines.
Trend Analysis and Trendlines
The price patterns in Figure 11.7 show trendlines drawn as part of those patterns. Trendline analysis on intraday charts is the same as that applied to bar charts. Up trendlines are drawn under successive lows and down trendlines are drawn over successive peaks. This is not true of the simplified point and figure chart, which we're going to study next. It utilizes 45 degree lines and plots them differently.
3 BOX REVERSAL POINT AND FIGURE CHARTING
In 1947, a book on point and figure was written by A.W. Cohen entitled, Stock Market Timing. The following year, when the Chartcraft Weekly Service was started, the book's name was changed to The Chartcraft Method of Point Sr Figure Trading. Several revised editions have been published since then to include commodities and options. In 1990, Michael Burke wrote The All New Guide to the Three-Point Reversal Method of Point Sr Figure Construction and Formations (Chartcraft, New Rochelle, NY).
The original 1 box reversal method of plotting markets required intraday prices. The 3 box reversal was a condensation of the 1 box and was meant for intermediate trend analysis. Cohen reasoned that because so few 3 box reversals occurred in stocks during the day that it was not necessary to use intraday prices to
construct the 3 box reversal chart. Hence the decision to use only the high and low prices, which were readily available in most financial newspapers. This modified technique, which is the basis of the Chartcraft service, greatly simplified point and figure charting and made it accessible to the average trader.
CONSTRUCTION OF THE 3 POINT REVERSAL CHART
The construction of the chart is relatively simple. First, the chart must be scaled in the same way as the intraday chart. A value must be assigned to each box. These tasks are performed for subscribers to the Chartcraft service because the charts are already constructed and the box values assigned. The chart shows a series of alternating columns with x's representing rising prices and the o columns showing falling prices. (See Figure 11.8.)
The actual plotting of the x's and o's requires only the high and low prices for the day. If the last column is an x column (showing rising prices), then look at the high price for the day. If the daily high permits the filling in of 1 or more x's, then fill in those boxes and stop. That's all you do for that day. Remember that the entire value of the box must be filled. Fractions or partial filling of the box don't count. Repeat the same process the next day, looking only at the high price. As long as prices continue to rise, permitting the plotting of at least one x, continue to fill in the boxes with x's, ignoring the low price.The day finally comes when the daily high price is not high enough to fill the next x box. At that point, look at the low price to determine if a 3 box reversal has occurred in the other direction. If so, move one column to the right, move down one box, and fill the next 3 boxes with o's to signify a new down column. Because you are now in a down column, the next day consult the low price to see if that column of o's can be continued. If one or more o's can be filled in, then do so. Only when the daily low does not permit the filling in of any more o's do you look at the daily high to see if a 3 box reversal has occurred to the upside. If so, move 1 column to the right and begin a new x column Chart Patterns
Figure 11.9 shows 16 price patterns most common to this type of point and figure chart-8 buy signals and 8 sell signals.
Let's take a look at the patterns. Since column 2, showing signals S-1 through S-8, is just a mirror image of column 1, we'll concentrate on the buy side. The first 2 signals, B-1 and B-2, are simple formations. All that is required for the simple bullish buy signal is 3 columns, with the second column of x's moving 1 box above the previous column of x's. B-2 is similar to B-1 with one minor difference—there are now 4 columns, with the bottom of the second column of o's higher than the first. B-1 shows a simple breakout through resistance. B-2 shows the same bullish breakout but with the added bullish feature of rising bottoms. B2 is a slightly stronger pattern than B-1 for that reason.
The third pattern (B-3), breakout of a triple top, begins the complex formations. Notice that the simple bullish buy signal is a part of each complex formation. Also, as we move down the page, these formations become increasingly stronger. The triple top breakout is stronger because there are 5 columns involved and 2 columns of x's have been penetrated. Remember that the wider the base, the greater the upside potential. The next pattern (B-4), ascending triple top, is stronger than B-3 because the tops and bottoms are both ascending. The spread triple top (B-5) is even stronger because there are 7 columns involved, and 3 columns of x's are exceeded.
The upside breakout above a bullish triangle (B-6) combines two signals. First, a simple buy signal must be present. Then the upper trendline must be cleared. (We'll cover the drawing of trendlines on these charts in the next section). Signal B-7, upside breakout above a bullish resistance line, is self-explanatory. Again, two things must be present. A buy signal must have already been given; and the upper channel line must be completely cleared. The final pattern, the upside breakout above a bearish resistance line (B-8), also requires two elements. A simple buy signal must be combined with a clearing of the down trendline. Of course, everything we've said regarding patterns B-1 through B-8 applies equally to patterns S-1 through S-8 except that, in the latter case, prices are headed down instead of up.
There is a difference between how these patterns are applied to commodity markets as opposed to common stocks. In general, all 16 signals can be used in stock market trading. However, because of the rapid movement so characteristic of the futures markets, the complex patterns are not as common in the commodity markets. Much greater emphasis is therefore placed on the simple signals. Many futures traders utilize the simple signals alone. If the trader chooses to wait for the more complex and stronger patterns, many profitable trading opportunities will be missed.
THE DRAWING OF TRENDLINES
In our discussion of intraday charts, it was pointed out that trend-lines were drawn in the conventional way. This is not the case on these 3 point reversal charts. Trendlines on these charts are drawn at 45 degree angles. Also, trendlines do not necessarily have to connect previous tops or bottoms.
The Basic Bullish Support Line and Bearish Resistance Line
These are your basic up and down trendlines. Because of the severe condensation on these charts, it would be impractical to try to connect rally tops or reaction lows. The 45 degree line is, therefore, used. In an uptrend, the bullish support line is drawn at a 45 degree angle upward to the right from under the lowest column of o's. As long as prices remain above that line, the major trend is considered to be bullish. In a downtrend, the bearish resistance line is drawn at a 45 degree angle downward to the right from the top of the highest column of x's. As long as prices remain below that down trendline, the trend is bearish. At times, those lines may have to be adjusted. For example, sometimes a correction in an uptrend breaks below the rising support line after which the uptrend resumes. In such cases, a new support line must be drawn at a 45 degree angle from the bottom of that reaction low. Sometimes a trend is so strong that the orig‑
111111U1111IMMIMIUMUMFigure 11.10 Examples of the Chartcraft three point reversal stock inal up trendline is simply too far away from the price action. In that case, a tighter trendline should be drawn in an attempt to arrive at a "best fitting" support line.
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