Profiting With Nortel Using Point And Figure And The Horizontal Target Count

10/08/04 03:46:43 PM

by Koos van der Merwe

In analysis of stocks today, point and figure analysis is rarely used. Yet if used correctly, it is very helpful. Here is a chart of Nortel and my analysis techniques using the strategies I teethed on in 1965.

Security: NT
Position: N/A

The doyen of point and figure charting is the work by A.W. Cohen. In 1965, his text was the only book available on detailed P&F charting, other than a short article in the ENCYCLOPEDIA OF TECHNICAL ANALYSIS. In those early days, charts were painstakingly drawn by hand, and technical practitioners used a three-point reversal, with a value per box dictated by the price of the stock and the size of the page.

Today, with computers, you name it, you got it. The computer automatically calculates the box size, and draws a chart based on the high and low of the share rather than the close. I am a traditionalist, and I stick to the old methods that I was originally trained in, so my analysis of Nortel is open to criticism.

Looking at the chart...

I used a box size of 0.1 and a three-point reversal of the close. This means that only with a movement of $0.30 in either direction will a new X or O drawn. Do remember, a point and figure chart does not take time into account, but only accumulation or distribution of the share.

The chart shows the following:

1. A break above a double top. I have always felt this was more a continuation pattern of a previous strong signal, so I would always use this pattern to add to a stock as a buy signal was given.

Figure 1: Trading Nortel using P&F

Graphic provided by: MetaStock.

2. A triple-top consolidation pattern. This is a very important signal. It shows that the share price started consolidating in a rising pattern, but the price fell back and actually gave a sell signal, as shown by the sad face on the chart. Many players would possibly have sold, or taken a short position with a downside target of $1.98. This is calculated as follows:

Horizontal target count:
Count the number of columns and subtract 1. Multiply this by the reversal allowed and the price per box. Add or subtract the resultant to the share price at breakout. This will give you a target price that will in many cases be exceeded by the stock prices, but it is always better to sell into a rising or falling market than to try and pick a top or bottom. Leave that "extra profit" to the risk taker.

In the chart at "12," the number of columns at the point of the sell signal is 8 - 1 = 7. Multiply this figure by the box size and the three-point reversal, and subtract it from the price at point of breakout -- 7 x 0.10 x 3 = $2.10. Point of breakout down was $4.08. Subtract $2.10 from this figure. $4.08 - 2.10 = $1.98.

The price reversed, and a more conventional triple-top pattern formed, breaking upward above $4.50 as shown by the happy face. This gave a target of $7.50 (10 x 0.10 x 3 = $3 + $4.50 = $7.50).

3. The price rose to a high of $7.05 before falling back in a profit-taking correction. It then rose, giving another buy signal, suggesting a target of $7.62 -- $0.15 above the original target of the triple top.

4. The price reached a high of $8.30 before falling back to give a triple-bottom sell signal at 4. Had you heeded the buy target as calculated, you would have sold prior to this sell signal for a comfortable profit. The sell signal shown would have suggested a target of $6.23. The price dropped to $5.33 before consolidating; it then broke below $5.66 suggesting a target of $4.16. Once again the target count was conservative, as the price fell to $3.57.

Once again, 6, 7, and 8 show a consolidation of the price, and you would have played it and made reasonable profits. At the moment, however, you would be out of the market, waiting for the price to break above the level at 8 for a triple-top buy.

In conclusion, point and figure and the horizontal count target strategy can give you good profits if you follow the strategy and do not become impatient, trying to catch a falling knife or feel that you are entering the market far too late. You can also extend the target by not subtracting one column in the column count -- my preferred target count.

This is an old technique that can offer very good profits.

Koos van der Merwe

Has been a technical analyst since 1969, and has worked as a futures and options trader with First Financial Futures in Johannesburg, South Africa.