One of the oldest trading theories that exists and still changes its shape is the Point and Figure trading theory. The analysis derived from it is based on rules developed over 125 years ago, and still, to this day; it offers important data that helps traders find profitable trades.
The Forex market is not that old. Everyone knows that. But, similar to other famous trading theories (Elliott Waves Theory is a perfect example), Point and Figure can be adapted to the Forex market conditions.
After all, the interpretation of a chart is the same if the basic rules are followed. Elliott Waves principle was developed for the stock market but can be used successfully in our times with the Forex market as well.
What is Point and Figure Analysis?
The starting point in understanding what Point and Figure represents should be the fact that the theory evolved in time. We’re talking about chart interpretation, and the change of this interpretation.
The method started back in time when trading tapes were being used in bucket shops. The idea was that traders needed to record prices (or write them down) and they were doing that in columns.
In doing that, the columns were rising, when prices were on an uptrend, or falling, when prices were on a downtrend. In time, traders started to note patterns in the way prices were rising or falling, and these patterns are now known as figure charts.
However, writing down numbers or quotes of a stock was a terrible thing to do, as it took a lot of time and space. To avoid that, traders started to use X’s instead of numbers. These are known as point charts.
Moving forward, in time, the rising columns were labeled with Xs and the falling ones with 0’s. The best illustration of the theory can be seen in the image below.
In time, patterns like; one box reversal or three-box reversal appeared, but as more and more data became available, the approach changed as well. Today, end-of-day point and figure charts are constructed differently.
Highs or Lows Considered
One way to build a daily Point and Figure chart is to use the high or the low as they are seen at the end of the trading day, or the close price. The first approach is also called the Cohen method, as he was the first one to stop using the tick data and to interpret bigger timeframes.
This was a good approach in the middle of the last century, but nowadays computers are offering the possibility to plot charts based on every minute’s data and are even more in-depth. Tick charts were suddenly popular again.
One of the newest approaches to treating Point and Figure charts is to use them as classical charts. This means that a concept like a trend line can be used effectively with this approach as well.
It will offer even more powerful support and resistance levels, not to mention that channeling in a Point and Figure pattern is a strong trading environment.
There are two ways to draw a trend line. The classical one is to connect higher lows in an uptrend and lower highs in a downtrend. As explained above, the resulting support and resistance levels are stronger in the case of a Point and Figure chart than in the case of a candlestick or a bar chart.
Another way is to use Gann angles to define the angle of the trend line to be drawn. It is being said that Gann believed that each financial product moves based on a specific angle.
In the case of the Forex market, following Gann’s guidelines, every currency pair should have an angle of its own. Gann defined the angles as 1×1 (the most important one), 1×2, 1×4, etc.
The 1×1 angle is the 45-degree angle, and this angle can be successfully used on Point and Figure charts to find out the breaking of support and resistance levels.
Other approaches call for similarities between trading the thrust of a classical contracting triangle with finding a specific target for a Point and Figure chart. In time, patterns using Point and Figure analysis were used to derive a target just as one is calculating a target based on the measured move of a reversal or continuation pattern in the classical technical analysis.
These days there is software designed to automatically transform the values of a chart into a Point and Figure one and traders must look only for reversal patterns (one box, three-box or five-box reversal patterns).
Like with any trading theory, there is a lot of room for improvement in the way the Point and Figure are interpreted. What needs to be understood is the fact that it is a more powerful approach for finding strong support and resistance areas than any other theories that exist today.