Point & Figure Charts
Motivated by e-mail from Ramon C.

I just learned about a type of chart that I'd never heard of before and ...

>Never heard of before? What else is new?
Pay attention.
Here's how it works:
 Each day we look at the High and Low for the day. For the first day, we enter a number of Os from the High to the Low. Example: High=\$27 to Low=\$24 The next day we see how much the Low has gone lower. If the Low did decrease, but by less than \$1, we do nothing. If the decrease is greater than \$1, we add another set of Os, down to that new Low. Example: Low decreased to \$22 so we add 2 more Os We continue doing nothing or adding Os ... so long as the Low is decreasing. If the Lows do not decrease, only then do we look at the High for the day ... to see if the High has increased by at least \$3. If not, we again do nothing.

>You spend a lot of time doing nothing!
The objective is to follow the Lows as they go down and ignore any local ups or down that aren't significant.
>Define "significant"!
We ignore decreases in Lows (or increases in Highs) that are less than \$1.
 >Okay, so we keep adding Os ... but what about when the Highs start going up significantly? Aah, then we start a new column of Xs. For our example (where the bottom O was at \$22), the High would have to be at least \$22 + \$3 = \$25 for us to start that new column .... else we'd do nothing. If the Lows stop decreasing and the High increases by at least \$3 we add a new column of Xs. Example: The Lows stop decreasing and the High goes up to \$26 We now continue to watch the Highs, so long as they are increasing, adding more Xs to the top of the column each time the High increases by at least \$1. >Huh? I thought \$3 was for the Highs and \$1 for the Lows. No, we continue with either the Lows or Highs as long as the changes, day-to-day, are at least \$1. That \$1 is called the box size.

We switch from O to Xs (starting a new column) when the Lows stop decreasing and the High increases by at least \$3.
That \$3 is called the reversal size.

>Don't tell me! We switch from Xs to Os when the Highs stop increasing and the Lows decrease by ... uh ...
By at least the reversal size.

>That's why it's called a reversal, eh?
Good for you
Notice some interesting things:

1. There are never less than 3 Os or Xs in each column, if the reversal size is 3.
2. Minor changes are ignored. A reversal must be "significant" in order to incorporate it into our P&F chart.
3. The horizontal axis has nothing to do with the time. It does not count days ... but the number of times we get a reversal.
4. Uptrends, downtrends, support and resistance levels are easily recognized ... so thay say.
5. The (sometimes) misleading effect of time is ...
Uh, not yet ... but while I'm working on it, look at this pretty stockcharts picture:

It seems simple, but it ain't (to me, at least).

Here's a flow chart I'll work on:

>Mamma mia!
My sentiments 'xactly ...

>So, have you finished the spreadsheet yet?
Well, sorta.

 >Where's the red and blue trendlines? Uh ... you draw them in yourself. See the red and blue lines on the spreadsheet? Just move 'em around and ... >That's pretty lousy. I mean ...? My purpose is to understand P&F charting ... and make a spreadsheet to play with. Moving those coloured lines around is just ... >Yeah, I know ... it's just playing. I assume the spreadsheet is 100% accurate. It carries my money-back guarantee.   >Very funny, but how do I identify the stock and ...

There's a bit more to the spreadsheet than is shown above. It's more like this
... and there's an explain sheet that looks like this:

 >Why would anybody want to use a Factor other than "1"? I have no idea. Maybe you'd use Factor = 0.1 if you're lookin' at the S&P500
 That'd give a P&F chart with smaller numbers, for, say the S&P500. >Huh? Why smaller numbers? If they're small enough you can use your fingers to keep track and ... >Can we just drop it? Okay. Just remember that, with Factor = 0.1, a Box and Reverse of 1 and 3 really means changes of 10 and 30 ... and that'd be a good idea for the S&P, eh? For a 10,000 DOW, you might want to use Factor = 0.01 so Box = 1 means changes of 100 (or 1%), like so:
>And the horizontal axis measures ... what?
It ain't days ... it's reversals.

Oh, one other thingy: the Box and Reversal numbers must be integers (in the spreadsheet)

 Strategies

The main benefit is that support and resistance levels jump right out at you (at least they should) because PnF filters out so much noise.
By adjusting the box size and reversal amount, you can visually determine trading opportunities.
For instance you might decide that with a certain box size and reversal amount that 80% of breakouts result in a profit of 4 boxes.
You can set your initial stop on breakout to be the reversal amount (say 3 boxes).
Then trail the stop as the trade moves in your favor, using the same reversal amount as the stop distance.
The possibilities are endless.

>Huh? Support and Resistance levels?
Yes, like so:

See this and this and this for more on P&F charts and this for P&F university