Point & Figure And Moving Averages

10/18/04 11:13:50 AM

by Koos van der Merwe

Last week, I wrote how I could have traded Nortel using point and figure charts. Here's a way to trade Nortel using two moving averages on a point and figure chart.

Security: NT
Position: N/A

In last week's article, I mentioned that one of the problems found with classical point and figure charting is that a trader would trade the share late -- that is, after the price has started moving. This was beneficial because the trader has the advantage of always trading in the direction of the trend.

Although I am a traditionalist, I must admit that computers today have given us an advantage. We are able to chart many variations in point and figure parameters, and look for more profitable trading strategies.

The point and figure chart of Nortel, as shown in Figure 1, is not the same as the one printed last week. Instead of a chart of the close, with a parameter of 0.1 and a three-point reversal, I have drawn a P&F chart using the range of the range of the high and the low. The parameter is computer-calculated at 0.1452 with a three-point reversal. I have also drawn a five-period exponential moving average (green) and a 15-period moving average (red) on the chart. The intention is to forewarn us of a future P&F breakout, either up and down.

Figure 1: Nortel and P&F plus moving averages. The point and figure chart of Nortel, as shown here, is not the same as the one printed last week.

Graphic provided by: MetaStock.

In analyzing the chart:
1, 2, and 3. Note how the crossover of the two moving averages have given a buy signal long before the P&F chart gave a buy signal. I have highlighted a P&F buy signal with a "bull," and a P&F sell signal with a "bear."

4. Here, the moving average gave a sell signal after the P&F chart gave a buy signal. The price did move down, but the moving average crossover gave a buy long before the P&F gave a buy signal.

5. The moving average gave a buy signal well ahead of the P&F buy, as shown by the bull.

6. The moving average would have taken you out well before the P&F sell signal, as shown by the bear on the chart. The P&F buy signal was not confirmed by the moving averages, so we would have remained short.

8. This was a buy, and
9. This was a sell.
10. and 11. Consolidation occurred, with the moving average at first suggesting a buy at "10," which changed to a sell signal at "11," as the price fell away in a P&F sell signal, as shown by the bear.

At the moment, the P&F is suggesting a consolidation phase that may culminate in a triple-top buy signal. The moving averages, however, are suggesting a sell signal. Any move of the short-term moving average (green) above the long-term moving average (red) would confirm that a triple-top breakout upward is imminent. Should this occur, using the horizontal target count as explained in my article last week, Nortel should rise to $7.16. (7 columns x 3 point reversal = 21 x 0.1452 (parameter) = 3.05 + 4.11 = 7.16)

Here is another arrow in your decision-making quiver.

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.