P&F Price Objectives: Horizontal Counts
Using Horizontal Counts for P&F Price Objectives
Point & Figure (P&F) price objectives can be determined using the horizontal count method with a consolidation or congestion pattern. This counting method is based on the width of the congestion pattern. The wider the congestion pattern, the higher the price objective upon the pattern break.
A congestion pattern ends with a break above the pattern high or below the pattern low. Chartists can then use a simple formula to estimate a price Extension and apply this extension to the consolidation high or low for a Price Objective. Keep in mind that these Price Objectives are rough estimates based on P&F charting techniques. There is no guarantee that prices will reach the objective.
Congestion Patterns
A congestion pattern or reversal must form before considering the horizontal count. Some Point & Figure patterns qualify as congestion patterns. These include Triple Top Breakouts and Triple Bottom Breakdowns, Spread Triple Top Breakouts and Spread Triple Bottom Breakdowns as well as Quadruple Top Breakouts and Quadruple Bottom Breakdowns. These classic P&F patterns clearly mark a congestion period that ends with a subsequent support or resistance break.
The chart below shows JP Morgan with a Quadruple Top Breakout in the upper right-hand corner. This Quadruple Top marked a congestion pattern as prices moved sideways from June (red 6) to December (red C). Notice that three reaction highs established a clear resistance level broken with the current column of X's. There are some other classic congestions and breaks on the chart.
The chart below shows Equinix (EQIX) with a pair of Spread Triple Bottom Breakdowns. This is just a Triple Bottom with a couple extra columns that spread the pattern a little wider. On the right-hand side, the red box marks the congestion pattern. Notice how the stock moved to the 93 box and traded sideways in January–February (red 2). One month ends, and the other starts with the red numbers. For example, January ends and February starts at the red number 2. EQIX broke Spread Triple Bottom support with a move below the prior two columns of O's.
As noted above, the congestion formation does not have to be a specific P&F pattern. There needs to be a definable congestion pattern that is at least five columns wide and a column that breaks this congestion. A clear support or resistance level should also be visible. The congestion ends when a column breaks above resistance or below support. Once broken, the width of the congestion is fixed and chartists can start the counting process.
Classic Patterns
The next step is to count the number of columns in the congestion pattern, i.e., the width. Counting is straightforward with the classic P&F patterns mentioned above because their width is defined. A Triple Top Breakout, for example, consists of five columns—three columns of X's and two columns of O's. The first two X columns establish Triple Top resistance, and the intervening O columns represent the two pullbacks. The third column of X's forges the breakout. Once the breakout occurs, multiply the pattern width by the box size and the reversal amount to estimate the price extension. This extension is then added to the low of the pattern for a target.
The chart below shows Chevron (CVX) with a Spread Triple Bottom Breakdown in February 2009. The red 2 signals the start of February, and the red 3 signals the end of February (beginning of March). The width of this pattern is seven columns, which can be counted from the green support line. The pattern is complete after the support break because the width cannot change after this congestion break. The width (7) is multiplied by the box size (1) and the reversal amount (3) for a projected Extension (7 x 1 x 3 = 21). This Extension is subtracted from the high of the pattern for a bearish Price Objective (69 - 21 = 48).
As with the vertical count, some schools of thought only use 2/3 of the projected Extension for bearish Price Objectives. A.W. Cohen, a pioneer in P&F charting, advocated a 2/3 Extension for bearish counts. This probably has something to do with the bullish nature of stocks. His 1984 book, How to Use The 3-point Reversal Method of Point & Figure, was written with stock market trading in mind.
There is also a Triple Top Breakout on the Chevron chart. This pattern represents a consolidation after a sharp advance. The width of the pattern (5) is multiplied by the box size (1) and the reversal amount (3) for an Extension estimate (5 x 1 x 3 = 15). This amount is then added to the low of the column for a bullish Price Objective (80 + 15 = 95).
Extended Congestions
While counting the width of a classic pre-defined P&F pattern is straightforward, counting the width of an extended congestion pattern is a bit different. Counts for extended congestions include the column leading in, the actual congestion pattern, and a column leading out. Also, note that some P&F practitioners include the columns leading in with the classic reversal patterns shown in the prior section. This means a classic Triple Top or Bottom would have one more column added to the count, thus making the estimated Extension a little larger.
Four pattern types qualify as extended congestions: two are reversal patterns, and two are continuation patterns.
A bullish reversal forms with a decline, congestion base, and an upside reversal breakout.
A bearish reversal that forms with an advance, congestion top, and reversal breakdown.
A bullish continuation that forms with an advance, congestion pattern, and continuation breakout to the upside.
A bearish continuation forms with a decline, congestion pattern, and continuation break to the downside.
For the two reversal patterns, the column leading into the congestion and the column leading out will be in different directions. A bullish reversal forms with a column of O's leading in (decline), a congestion base, and a column of X's leading out that breaks congestion resistance.
The chart below shows Coca-Cola (KO) with a bullish reversal pattern in red. The long column of O's establishes the downtrend. The congestion extends for 16 columns, ending with the breakout column leading out. All told, the width is 18 columns, which is exceptionally long. Using the formula above, the Price Objective would be 90 (18 x 1 x 3 = 54, 36 + 54 = 90). Again, take these price objectives with a grain of salt and employ other aspects of technical analysis for confirmation. The KO chart also shows a bearish continuation congestion pattern (blue).
A bearish reversal forms with a column of X's leading in (advance), a congestion top and a column of O's leading out that breaks congestion support. The State Street (STT) chart below shows a column of X's leading in and forming a new high above 55.
A congestion pattern formed as the stock traded flat for six columns. Congestion support was broken when the column of O's exited the pattern to fix the width at eight (one column leading in, six for the congestion, and one column leading out). As noted above, some investors use 2/3 of the reversal amount for bearish price Extensions. A full Extension targets a move to 31. A 2/3 Extension targets a move to 39.
The lead-in and lead-out columns for continuation patterns are in the same direction. A bullish continuation consists of an advance with a column of X's leading in, a congestion, and an upside breakout to signal a continuation of the prior advance. A bearish continuation consists of a decline with a column of O's leading in, a congestion, and a continuation lower with a congestion support break.
The chart below shows TimeWarner (TWX) with a bearish and bullish continuation congestion. The bearish pattern formed after a long O's column broke below the prior lows. The stock traded flat for five columns and then broke congestion support to signal a continuation lower. Two extensions were calculated, one based on the full extension and one based on a 2/3 extension.
Signal Frequency
The examples above are based on daily price data with standard P&F box sizes. Securities priced from 5.01 to 20 have 50-cent boxes, and securities priced from 20.01 to 100 have $1 boxes. These daily P&F charts provide a fairly long-term picture, as most extend back to 2009. If you prefer looking for more signals, try smaller box sizes and using intraday price data, such as 60-minute data. A 20–50 cent box size with 60-minute data works well for the three to six months (see chart below).
Assessing Risk
Establishing a Price Objective only covers the reward part of the risk-reward equation. Chartists should also study the chart to assess risk. For bullish patterns and upside price objectives, a move below support or the pattern low would negate a breakout. The box below the pattern low often marks the worst-case level for a pattern failure.
Similarly, a Double Bottom Breakdown or a contradictory P&F pattern would argue for a reassessment. For bearish patterns or downside price objectives, a move above the resistance or the pattern high would negate a breakdown. The box just above the pattern high often marks the worst-case level for a pattern failure. Similarly, a Double Top Breakout or a contradictory P&F pattern would argue for a reassessment. There are sometimes indications of potential failure before price hits the worst-case level. Because of this, it's best to employ other technical analysis techniques to measure risk and monitor the unfolding trend.
The Bottom Line
Horizontal price objectives provide chartists with a general price target based on the width of the pattern. This makes sense, as longer congestion patterns mean more energy is stored for the subsequent break. It is like a smoldering volcano just before it blows.
While the breakout is the most important element for these patterns, nimble players may be able to anticipate a bullish resolution by buying near support. This would greatly improve the risk-reward ratio. From a P&F standpoint, however, the pattern is not confirmed until there is an actual breakout. Once a breakout occurs, very wide patterns can often produce unrealistic Price Objectives. While a stock can go to zero, most will not even come close to zero. Therefore, horizontal counts that produce negative Price Objectives are best ignored.
Similarly, a Price Objective that forecasts a 300% advance should also be taken with a grain of salt, especially if the stock is not part of the latest bubble. As with all indicators and techniques, it is important to confirm your findings with complementary technical analysis tools, such as momentum oscillators and chart patterns.
Further Study
Thomas Dorsey's Point & Figure Charting examines the basic ideas and key patterns of P&F charts. Dorsey keeps his analysis simple and straightforward; as a relative strength disciple, he devotes a complete chapter to relative strength concepts using P&F charts. These concepts are tied in with market indicators and sector rotation tools to provide investors with all they need to construct a portfolio. Additionally, Dorsey incorporates lessons on how to use P&F charts with ETFs.
Point & Figure Charting Thomas Dorsey |
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