That Figures, Part 3
That Figures, Part 3
When technicians chart using Point and Figure charts, they are doing so to identify and stay in longer trends. We do not want to be shaken out too early on a trade that could have yielded much more profit. Therefore, we would want to make our signals less sensitive so we have fewer of them, or we need to use some sort of filter so that we do not take every trade we happen to see.
We must have a trading plan or system designed around the use of our technical tools. In my previous articles on Point and Figure charting (That Figures and That Figures, Part Two), I told you the need for identifying your entry, stop, and even projected target for the trade before entering it. Supply and demand levels work the same in Point and Figure as they do in other styles of charts. Look for an area where trend reversed strongly. Your typical rally-base-drop or drop-base-rally would do just fine. You should look to buy or sell when you receive entry signals in those areas only.
Figure 1
One of the simplest filters is to make sure the trades we take meet the standard 3:1 reward to risk ratio we always follow in our classes. Since we know our entry, our stop, and we can use supply and demand or even the horizontal or vertical projections for our targets, there is no reason why we cannot take only the trades that offer the greatest potential for success and the lowest risk in relation to it.
Figure 2
The overall trend of price is something we look at to determine whether we should be a buyer or a seller of a stock. Why should it be any different with P&F charts? The difference in drawing the trendlines is that they are traditionally only drawn at 45 degree angles from a low or from a top. You would not connect multiple lows for an uptrend or multiple tops for a downtrend as you would with candles.
Figure 3
We can also limit out risk in trading by only trading with the trend. If you are above an uptrend from a low, only look to enter trades on buy signals. Use the selling signals to exit those longs only. You would not take a sell signal as an invitation to enter a short as it is counter trend and has a lower probability of working. The short positions should only be entered when you have a sell signal when you are trading below a trendline drawn from a high. You would use buy signals to exit those shorts, but not to enter longs.
Breaking a previous column of X's is a simple signal. So is breaking a previous column of O's. I showed you some patterns that can be used as more advanced entry signals. There are many others. Some technicians will only enter trades on a complex signal and then exit upon receiving a simple signal. This will also serve to filter out a lot of unnecessary trades.
There are a lot of choices to screen out trades that are marginal. We want to trade smarter, not more. No matter what system you create, be sure that it manages your risk properly and offers you the opportunity to identify and take high probability, low risk trades. There are plenty of them in the markets waiting for you.
- Brandon Wendell
About Brandon Wendell
Brandon has appeared as a guest on CNBC, Bloomberg TV, and Fox Business Channel. He has conducted special seminars for CNBC staff on technical analysis of the financial markets. Brandon has published articles in The Trader's Journal, Forex Journal, Investor Magazine, and Investor’s Business Daily. Brandon has also appeared as an industry expert speaker at the Trader’s Expo, The Money Show, and Asia Traders and Investors Conference.
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