CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 74-89% of retail investor accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
With this article, we want to bring to your attention a long-forgotten trading methodology. Truth be told, it isn't forgotten, just little known by today's retail currency traders. It is called point and figure charting.
Strangely enough, point and figure is one of the oldest trading theories that exist. With roots back in the late 1800s, it suffered some critical changes in time.
Traders in the 21st-century (especially currency traders) suffer from the need to action. They want to see quick moves, the take profit hit fast, and off you go to the next trade.
The reality, though, has been crude with most retail traders. The FX market doesn't care about what traders want. Instead, it morphs every day into something new, due to the increased number of inputs it receives.
Yet, some trading theories didn't survive so long if it weren't something good about their core principle. We aim here at bringing to surface the basics of the point and figure charting and trading.
Computers make it easier nowadays to draw all kinds of charts. From candlesticks to Kagi charts, Renko to line charts, we can customize the way we see the price action as we want. But none of those charts filter the right price action as the point and figure ones.
Point and figure charting has a significant advantage when compared with other types of charts. It filters for the unnecessary market noise.
In a world dominated with news that hits the wires every single second, that's an important feature every retail trader must consider. In other words, point and figure chart display only the relevant market price action. The rest is simply scrapped. Or, ignored.
In the end, traders end up watching and interpreting a different kind of chart. A chart that shows only the relevant market moves, counting time on the horizontal in a different manner.
Yet, all trading tools (e.g., trendlines, indicators, etc.) work on point and figure charts too. However, with better results.
That's precisely what you'll see on a point and figure chart. A series of Xs and Os.
More precisely, point and figure charting is based on vertical columns showing either Xs or Os. Just like the chart below:
This is the EURUSD daily timeframe showing vertical columns of Xs and Os. As it is easy to note, Xs are bullish, and Os are bearish.
The idea behind understanding a point and figure chart is to interpret each X, and O. Called boxes, they have a predetermined size.
In other words, the chart will add a new box (either X or O) only when and if the EURUSD pair travels a predetermined distance each day. And, closes beyond that distance.
Back in the days when such charts were plotted manually, for each market security (mainly stocks), the box had different sizes. After all, it depends a lot on the value, volatility, and so on.
Nowadays, we can also use standard sizes based on each currency pair's volatility. For instance, let's assume we set up the box for the EURUSD pair as 75 pips.
What it means for the chart is that we'll see another box only if the EURUSD closes a day with a distance of more than 75 pips. If not, the chart remains the same. Unchanged.
Another way is to use the ATR (Average True Range) with a period of 14 as the standard size of the box. This approach appeals more to Forex traders because it standardizes the box in such a way it is used on all currency pairs.
For the sake of understanding the basics of point and figure charting, we won't use the ATR. Instead, we'll use the 75 pips example as for the size of one box. And, we'll start from the current pricing.
The chart tells us that the EURUSD is in a bearish trend. There are currently five O's showing the bearish trend.
Using the 75 pips rule, every time the EURUSD has a bearish day and closes more than 75 pips from the opening price, the chart plots a new O. If not, the chart remains unchanged.
How about the reversal? The typical reversal has a 3-box size. More precisely, if the EURUSD has an up-day bigger than three-times the size of the original box, the chart plots an X.
As a rule of thumb, the reversal always starts one box higher (in a bullish one) or lower (in a bearish one) than the previous column. In the case of the 75 pips as the size of the box, a reversal day needs 215 pips in the opposite direction. And that's how a trend changes.
Keep in mind we used the 75 pips distance just for the sake of exemplifying. In reality, boxes are smaller or bigger, depending on the ATR and the market traded.
By far, the most prominent advantage is that it filters the noise. And so, the false moves.
Traders end up remaining on the right side of the market. This is important, considering how many days of consolidation are there.
Here’s the EURUSD showing the price action for the last two years. But, instead of point and figure, this is a candlesticks chart.
As you can see, the point and figure compresses the time, counting and interpreting only the relevant market moves. This is valuable information for traders wanting to stay on the right side of the market and not get caught in irrelevant, long-lasting consolidation areas.
Point and figure charting survived the test of time because it shows only the relevant market moves. The key is to find the right box size for each currency pair or instrument traded.
Using the ATR is one option. Another one is to use historical data and adapt the size of the box for each currency pair. For instance, some cross pairs travel less than major ones, some don't.
In using point and figure charting, traders’ benefit from skipping long consolidations and staying on the relevant trend. After all, that's all that matters in trading, right?