Monday, July 30, 2007

Why you need Point and Figure Charts as an essential tool of the trade

The answer is because the long term trend matters. Knowing where you are on the road to prosperity is the first step to any strategy. Whether or not you are a long term investor, a daily trader or a swing trader, you need to know how the fundamental law of supply and demand is influencing the price of any stock you wish to trade. If you believe that you can make decisions using price and volume as the main ingredients for your technical analysis, then you must believe that they are caused by simple supply and demand pressures.

Once you know “the condition” of the stock you wish to trade, you will have a different strategy based on its current status. I decided to use two securities picked from Another Brian’s Canadian screen. They are Miranda Techno (MT.TO) and Mega Uranium (MGA.TO). Why? Perhaps I like to be in the Middle of the alphabet. Or maybe the recent uranium price collapse is of interest to me.

I have to assume that you know the basics of Point and Figure Charting (P&F). If you don’t, I strongly suggest you Goggle it. I know that Stockcharts has a good tutorial written by Arthur Hill on that.
Click here for this tutorial

Also, Dorsey Wright & Ass have made it a business and they have some free information available on their web site.
Click here for this tutorial

The advantages of P&F are numerous:
-1- There is no guessing as to what the appropriate trend line is.
-2- The supports and resistances are easy to identify.
-3- Some techniques can be used to make price objectives, but that’s beyond the scope of this article.

Miranda Technologies (MT.TO) is the first stock that I want to review.

Here is the Legend:
Dark Green line = Bullish Up trend line sloping upwards at a 45 degree angle
Red line = Bearish Down trend line sloping downward
Light green horizontal line = Support line
Blue horizontal line = Resistance line
X in a green square = Breakout
O in a yellow square = Breakdown

If your prefer an Excel version to download, here it is

In my experience, drawing trend, support and resistance lines is very straight forward with P&F. Doing the same with a mainstream chart is more of an art and often subject to your interpretation. I prefer the objectivity of P&F. That means that my emotions will not enter into the equation when I must make rational investment or trading decisions.
There are many stories illustrated by this chart. But the main one is shown on the “H10” and “H11” squares. First we had a breakdown from support of $16.50 which put the stock right on the up trend line. Then we had another and more significant breakdown of the up trend line of $16.00. The bull market for this stock was over. That meant that the game was over and from that point on, bull market tactics had to be replaced by bear market strategies. A wise trader would have put a stop loss at $15.50, regroup and realizing that the game is going to be different, take out the bear book and apply the recipes for such an environment. As soon as the breakdown occurred, a new long term trend line appears. It is the Red bearish trend line which will be the new line in the sand. I could go on with this story, but suffice to say that later on in column “I” and “K”, wise traders recognizing the bear would twice short the stock as it attempted to touch and exceed the red down trend line. Yes, shorting at or near the down trend line is often executed by the pros.

So if you trade MT.TO in the near future, please be aware of its current trend. For example, buying into a bear rally is quite different than buying into a bull trend.

Finally Mega Uranium (MGA.TO) is quite a different sight.

If your prefer an Excel version to download, here it is

This stock is still clearly in a bull market trend, so bull market strategies are still in force even after a drop from a top of $8.50 to its present price of around $5.00. Depending of the type of trader that you are and of your risk aversion, there are different trading strategies available to you at this point. Whatever your choice, I find it comforting to know the following points before I trade this stock:
-1- Because we are in an uptrend, I generally should not try to short this puppy until the price has broken the uptrend line at $4.00, the suitable stop loss price for the long term investor by the way.
-2- The stock is currently at double support at $5.50. This is a very likely spot for buyers to come in. Depending on the way you evaluate a target price for this stock, it may be a low risk/high reward trade at this point given that the logical stop price is just under support at $5.00 (T11 is the red square). We could have a loss of $0.50 for a gain of $(...put your estimate here…). I typically require a minimum of 2 for 1 ratio to be worth my while. But 3 to 1 is more to my liking. Of course if we have a breakdown from support the next logical support would be the up trend line at $4.25.

So the moral of the story is that P&F analysis allows you to identify the prevalent trend and using support and resistance it also allows you to evaluate the most likely trading ranges within that trend. I could not do without it

The Word


The information presented on this site is for educational and entertainment purposes only. This site contains no suggestions or instructions that you must follow, do your own research and due diligence before committing your cash to the markets. Your on your own.