)
Charting price-volume information in the hopes of seeing patterns is the basis of technical analysis. In the most common of price-volume charts, time is mapped on the X-axis, while prices are represented as lines or bars on the Y-axis with flags marking open and closed prices. Volumes are usually marked as columns on a secondary Y-axis.
Another method of graphing is less commonly used but is probably closer to what traders "see" mentally when looking directly at price numbers rather than graphic representations. This is point and figure charting. In a P&F chart, the chartist uses a cross (X) to represent a price rise and a nought (O) to represent a fall. The chart is divided into boxes. Each box shows what the trader considers significant price movement. Any price change less than the box threshold is ignored.
For example, say a stock is trading at Rs 100 and the trader decides he will only log moves of 50 paise or more. He will mark an X, or O, if the price goes to 100.5 or till 99.5, respectively, and will ignore a price change to, say, 100.40 or 99.55.
Let us say we have a rising trend, with the stock moving from Rs 100 to 110. This will be represented by 20 crosses stacked on top of each other in the same column at 50p intervals. It's important to understand that it doesn't matter if this move happens within a single day or over a period of months.
Price reversals are always marked in new columns. Let us say the price drops from 110 to 107. The trader will then mark six noughts in a new column across 107-109.5 levels. Again, the trader decides what is a significant reversal. A '3-box rule' is often used. That is, if the price-box is 0.5, a significant reversal will be marked only if the price changes by 1.5. A price downturn of less than 1.5 would be ignored if the stock is running in an uptrend.
In P&F, prices are, therefore, marked only if there are significant changes. Time is ignored. Volume is ignored. Indicators like moving averages, momentum, relative strength index, etc, are impossible to superimpose due to the lack of time representation. The trader takes just one price - it could be the close, the high or the low. Moves of less than significant box value are ignored and reversals of less than the significant 3-box value are ignored.
One big advantage is that the trader can draw P&F charts very quickly by hand, or even compute these mentally, by only looking at the price. Another advantage is that the trader sets his own thresholds for significance in terms of price changes. A day trader might set those boxes at one level; while a long-term investor will set these at another level.
Paradoxically, the suppression of information is what makes P&F charts useful in contrast to other charting methods, which incorporate as much information as possible. By minimising information, the P&F format creates strong filters.
P&F chartists swear the format highlights trends and trend reversals very sharply, thus enabling mechanical trading systems.
It also lends itself to easy stop-loss setting; the stops can be set in multiples of box units. It is worth experimenting with P&F techniques in circumstances where other chart systems don't give clear signals.
At this instant, a P&F chart of the Nifty suggests the major market index is quite bullish, despite the range trading of the past few sessions. A P&F chart of the Bank Nifty suggests, however, the financial index is running into heavy resistance.
The Bank Nifty has a high-correlation, high-beta relationship with the Nifty. If these two opposed trends continue, the Nifty's continued rise would have to be fuelled by stocks drawn from sectors other than banking.
