You know what point-and-figure charts look like: an elongated version of tic-tac-toe. Yet, they provide another means of determining a trend. In fact, their advantage over a bar chart is the specific buy and sell signals - no personal interpretation is needed.

The pork belly chart is shown for the same time period in both bar chart and point-and-figure form. The differences in appearance are striking. This is due mainly to the lack of a time scale on the point-and-figure chart. Time is irrelevant; price movements are charted only when they occur. On days when no new high or low is made, no additional entries are made on the chart.

Also, on a point-and-figure chart, the price scale marks the space between the lines rather than on the lines as bar charts are marked.

 

Upward price action in a point-and-figure chart is indicated by X's; downward movement by 0's.

The point-and-figure chart gives a simple buy signal when an X in the latest column has filled a box that is one box higher than the preceding column of X's. A simple sell signal appears when the latest column is in 0's, and the 0's fill the box below the previous column of 0's. These simple signals are marked on the pork belly point-and-figure chart on this page.

Each point-and-figure chart you see will have a box size and reversal number. In this case, it is 40 x 6, which means each box is worth 40 points, and it takes a price change of six full boxes in the opposite direction to start a new column. When beginning a new column, the box adjacent to the last entry is always left empty.

When plotting X's, wait for the price to rise to fill the entire box before adding another X to the current column. Likewise, when working with a down trending column of 0's, wait for prices to drop to fill the whole box before adding another 0 to the column.

Based on a single day's price action, you don't add to the current column and then plot a reversal. If you continued the current column of X's or 0's, don't start a new column based on one day's price action.

For example, if the most recent column is X's, look at the daily high first. If the high is high enough to require drawing one or more additional X's in the current column, the daily low is ignored, regardless of how low it might be. If the trend has truly reversed, it will be revealed the following day Only if you can't add an X do you check the low to see if you can fill the required number of boxes for a reversal.

A similar procedure is used when the current column is 0's. Look at the daily low first and ignore the high if you can add to the 0 column. As before, only if you can't add an 0 do you check the high to determine if you can add enough X's for a reversal. A flow chart for plotting a 3-box reversal chart is below.

Each vertical column will always have at least the number of X's or Os needed for a reversal. For example, the pork belly illustration of a 40 by 6 box size and reversal will always have at lease six X's or 0's in each column.

There are many formations on point-and-figure charts, but breakouts of double or triple tops or bottoms are probably the most reliable ones. The last rally (the June rally) on the pork belly point-and-figure chart to just over the 70 f level was a breakout of a triple top.

Trendlines can also be used on point-and-figure charts. Most traders agree that the 45-degree trendline, which cuts each box diagonally, is more useful than connecting highs or lows as you do on a bar chart.

An uptrend line is started at the lower right hand comer of the box with an 0 and drawn up to the right at a 45-degree angle. A downtrend line begins at the upper right hand comer of a box with an X and is drawn down at a 45-degree angle to the right.

Breakouts of point-and-figure formations must completely clear the 45-degree line, and, if applicable, move one box higher or lower than the previous column of like letters.

The disadvantage of point-and-figure charts is that they may be slow to signal trend changes. Since point-and-figure traders are buying and selling breakouts, follow through is needed for a profitable trade. Similar to moving averages, they don't work well in sideways markets.

One way to use the point-and-figure selectively is to ignore minor trend reversals when a new column is started. Some whipsaws may be reduced by ignoring minor signals unless they are in tune with the major trendline on the point-and-figure chart.

And that, in a nutshell, is an introduction to Point-and-Figure Charts. Now go out there and give it a try...

Although the average directional movement index (ADX) isn't used as frequently as some of the popular technical indicators, the ADX line has definite advantages because it filters out a lot of the false oscillator signals which are frequently given early in a move.

A longer-term trader can stay with trending positions longer by following the simple guidelines for the ADX line. According to research by computer trading expert Bruce Babcock, a climb by the ADX line above 40 followed by a downturn signals an imminent end to the current trend (whether up or down). When this signal is given, traders should take profits on existing positions. More aggressive traders can use this signal to consider taking positions for a possible move in the opposite direction.

The charts on this page show how the ADX works. The ADX line on the feeder cattle chart gave two signals during the year. The first downturn accurately marked the top in February, and the second downturn above the 40 level signaled a bottom in late summer. Note that the signal in late July was actually more than a month ahead of the actual bottom in September. The ADX warns you of an end to the trend. In this case, it gave you more than a month's warning.

Like the feeder cattle signals, crude oil's ADX gave two signals during the year, one at the summer low and the second at the winter high. Both signals were given by climbing above 40 and turning down.

The ADX signals by feeder cattle and crude oil signaled the end of one trend and the beginning of a new trend. But the ADX is not designed to signal a trend reversal. It only signals the end of the existing trend.  A good example of not signaling a trend reversal is T-Bonds. The end of the strong spring rally was accurately marked by the ADX signal in June. Then T-Bonds consolidated in a coil until the upside breakout in the fall. An ADX climb above 40 and downturn in November signaled another consolidation.

Usually, a commodity gives no more than a couple ADX signals during a year, unless the market has particularly volatile price action. The ADX is less helpful during sideways markets. During extended consolidation periods, the ADX line will slip toward 10. When ADX approaches 10, a major move is usually about to take place. But the ADX line doesn't tell you which direction it will go. You have to rely on other indicators for the probable direction of the next move.

In summary, if the market is trending (whether up or down), the ADX line should be rising. During an extended consolidation period, the ADX line will slip toward a low number.

Time to give it a try - can you spot the potential trend change as indicated by the ADX at the bottom of this MarketClub chart:

The ADX indicator rose above 40 at the end of November - indicating a potential end to the uptrend that began in September. As mentioned in your lesson, it does not indicate which direction the trend will move in next, only that the current trend is most likely coming to an end...

Like the Relative Strength Index (RSI), stochastics is another popular oscillator to gauge price momentum and judge the age of a price move. Stochastics is not a new oscillator. The idea was originated by a Czechoslavakian and perfected by Dr. George Lane, editor and publisher of Investment Educators in Skokie, Illinois.

But unlike the RSI, which measures momentum based on the changes in daily settlement prices, stochastics has two lines and the calculations are based on the rate of change in the daily high, low, and close. The concept for stochastics is based on the tendency that as prices move higher, the daily closes will be closer to the high of the daily range. The reverse is true in downtrends. As prices decrease, the daily closes tend to accumulate closer to the lows of the daily trading range. This concept also holds true on daily, weekly and monthly charts.

Stochastics can be calculated for any time period. Choosing the right time period for the stochastics is similar to choosing the right number of days for a moving average. In effect, stochastics is a trend-following method since its lines will cross after tops and bottoms have been made. Choosing too short a time period will make the stochastics so sensitive that it becomes virtually worthless. If the time period is too long, it is too slow to turn and too insensitive to be useful.

Both bearish and bullish divergence are shown on the accompanying S&P chart. There's bearish divergence in late February when S&P prices make a new high but the %D line stays far below its winter high. This divergence accurately warned that a top was forming. An equally good signal of a bottom was the bullish divergence during the spring. The S&P was making new lows into early May, but the %D line held above the lows made during March.

Markets seldom go straight in one direction without a pause or correction. When prices move up and appear to be ready to correct, the market is called overbought. When prices have been moving down and appear to be ready to rebound, the market is oversold. As a mathematical representation of a market's overbought or oversold condition, stochastics tells you when prices have gone too far in one direction.

Values above 75 (in the shaded area) indicate the overbought zone. Values below 25 (also shaded) indicate the oversold zone. (Some traders prefer using 80 and 20 as the parameters for overbought and oversold markets.) In sustained moves, stochastics values may remain in these shaded areas for extended lengths of time.

There are at least two popular ways traders use stochastics for buy and sell signals. A conservative approach is to wait for both the %K and %D to come out of the shaded area to issue the signal. For sell signals, a conservative trader waits for both lines to rise into the overbought zone and then fall below 75 again. An opposite pattern is followed for a buy signal. After both lines drop below 25, the buy signal is given when the stochastics lines climb above 25 again. This is a more conservative approach because you will be slower in taking a position, but it may eliminate some false signals.

For more aggressive traders, the buy and sell signals on the stochastics charts are generated when the two lines cross. For most traders the buy and sell signals are flashed when %K crosses %D, as long as both lines have first gone into the overbought or oversold zones. This is similar to the buy and sell signals of two moving averages.

Waiting for the stochastics lines to come out of the shaded area will sometimes prevent false - signals. For example, If you, were watching for a buy signal on the stochastics chart for the NYSE composite index during the August-September period, %K crossed the %D line in early August and at least five more buy signals were given before the trend finally turned up in early October. An aggressive trader who went with the first crossing of the lines would have been stopped out at least a couple times before finally getting on board for a good move up. But the more conservative trader would have been waiting for both lines to climb out of the oversold area before buying, thus avoiding the whipsaw signals in August and September.

Oscillators are notoriously unreliable in signaling trades against the trend. For good stochastics signals, you'll need to trade with the longer-term trend (Giant Footprints) . Follow only the buy signals in uptrends and only the sell signals in bear markets. However, in a trading range market, stochastics will give good buy and sell signals.

Buy and sell signals are shown on S&P 500 chart. With stock indexes in an overall uptrending pattern, the stochastics buy signal would have helped traders establish long positions on the buy signals in November, December and March. The sell signals in February, June and July could have been used to take profits on long positions.

Some traders prefer to see the %K line cross the %D line on the right side. This is called a right-hand crossing. In other words, %K is crossing %D after %D has bottomed or topped. When the %K crosses the %D line before the %D has bottomed or topped, it is referred to as left-hand crossing. Of course, this can only be seen in hindsight because, at the time the two lines intersect, you don't know if the %D has reached its ultimate top or bottom.

Left-hand crossings are not as common as right-hand crossings. You can see a left-hand crossing on the S&P chart in early February. The %K dipped below the %D before the %D had reached its ultimate peak.

Stochastics is a very useful technical indicator which helps you with your timing, especially when it is used in conjunction with the other trading tools.

Let's try putting it into practice. Using the slow stochastics indicator pictured at the bottom of this MarketClub chart, try to determine the two overbought and oversold areas:

This is a great example of why stochastics are very useful, but, like any other indicator, not always 100% reliable...

The second 'oversold' indication turned out to be accurate - shortly thereafter, both lines crossed back above 20 the Euro took an upward turn and rose about $0.90 (or 9,000 pips).

Likewise, both 'overbought' indications proved to be accurate - just after each, the EUR fell about $0.30 and $0.80 (3,000 and 8,000 pips) respectively.

However, the first 'oversold' indication turned out to be a relatively false signal. The EUR did not undergo a very significant turn-around. Instead, it continued to go sideways briefly then resumed its downward plunge...

Just one more reason you should verify a signal from one indicator by checking for a similar signal from another indicator - such as MarketClub's proprietary Trade Triangles. One quick glance at your chart - for a red or green triangle - and you'll instantly know which way the trend is most likely to go. It just doesn't get any easier than that...