﻿ Understanding the probability of stock price trajectory with Point and Figure Charts | ComponentOne

# Understanding the probability of stock price trajectory with Point and Figure Charts

In this blog, we'll walk you through how Point and Figure chart can help us take advantage of simple chart patterns to record the battle between supply and demand – a basic law that affects our day-to-day life.

How do we understand the probability of stock price trajectory? Many investors buy stocks based on fundamentals, primarily because they make stocks easier to understand, and an abundance of available research exists on the topic. A fundamental analysis only provides half of the equation that can be utilized for effective trading. Once the stock has been determined to be fundamentally sound, one needs to understand the possibility of prices changing and the probability prices going up or down. Which probability is higher?

This is the point where technical analysis plays an essential role in determining when to enter and exit the trade.

Realizing the importance of technical analysis isn't enough; we need to utilize it effectively. With the variety of chart types, technical indicators, and overlays available in the today's market, it's not always easy to conduct a technical analysis. We need to understand the patterns.

## Understanding Point and Figure Chart Patterns

Point and Figure chart patterns, like the stock market itself, are usually classified as bullish and bearish. When the market supports higher prices, sticking to the bullish chart patterns when going long usually produces superior results in investing. Conversely, when the market does not support higher prices, sticking to the bearish chart patterns when shorting a stock usually produces superior trading results.

The key to interpreting chart patterns is to determine when the stock exceeds a point of resistance or support. Resistance is the point at which a stock reaches a particular price and encounters selling pressure - the point where supply exceeds demand. Support is the point where stock encounters buying pressure, or when demand exceeds supply.

In the next section, we’ll observe different Point and Figure chart patterns to understand what they can tell you about a stock. We’ll render stock data of Twitter, Google, and Facebook to help identify buy and sell signals using these patterns.

## How the Double Top Breakout Point gives the most basic buy signal

The Point and Figure chart gives its most basic buy signal at Double Top Breakout. A bullish pattern in nature, Double Top Breakout occurs when the stock exceeds the previous column of X. This pattern signifies that the demand has taken control of supply, and prices are expected to rise further. When the columns of rising O's are rendered before the breakout column, this pattern produces greater results:

Trading strategy for Double Top Breakout is to buy at breakout and Stop-loss can be set at three-box reversal. The above chart shows Double Top Breakout for Twitter stock data. In both the cases (highlighted breakouts), the previous column made rising O’s and the stock rose significantly thereafter.

## How the Double Bottom Breakdown gives the most basic sell signal

Point and Figure chart gives its most basic sell signal at double bottom breakout. A bearish pattern in nature, Double Bottom Breakdown occurs when the stock declines from the previous column of O. This pattern signifies that the supply has taken control of demand, and prices are expected to decline further. When the columns of falling X's are rendered before the breakout column, this pattern produces greater results:

Trading strategy for Double Bottom Breakdown is to sell at breakdown and stop-loss can be set at three-box reversal. The above chart shows a Double Bottom Breakdown for Twitter stock data. In both the cases (highlighted breakdowns), previous column made falling X’s, and the stock declined significantly thereafter.

## How the Triple Top Breakout shows how stock rises

Triple Top Breakout is an advanced version of Double Top Breakout in which stock rises thrice to a certain price level. The first two times stock reaches that level, it encounters selling pressure and pullback happens. The third time the stock reaches to that same level, demand overtakes supply and a strong bullish breakout pattern is formed.

This pattern produces greater results when columns of rising O’s are rendered before the breakout column. The general rule is that the stock is more bullish if it has more tops, and the breakout happens in less interval of time. The greater the number of times a stock bounces off a resistance level, the stronger the breakout will be when it happens.

Trading strategy for Triple Top Breakout is to buy at breakout and stop-loss can be set at three-box reversal. The above chart shows a Triple Top Breakout for Twitter stock data where the highlighted breakouts happen after the columns of rising X's occurred thrice.

## How Triple Bottom Breakdown shows stock declines

Triple Bottom Breakdown is an advanced version of Double Bottom Breakdown in which stock declines thrice to a certain price level. The first two times stock declines to that level, it encounters buying pressure and pullback happens. The third-time stock declines to that same level, supply overtakes demand and a strong bearish breakdown pattern is formed. This pattern produces greater results when columns of falling X’s are rendered before the breakout column:

Trading strategy for Triple Bottom Breakdown is to sell at breakdown, and stop-loss can be set at three-box reversal. The above chart shows a Triple Bottom Breakdown for Twitter stock data. Since the previous column of X rendered falling X’s, price declined significantly thereafter.

## How Bullish Catapult Formation indicates when to buy and sell

Bullish Catapult formation is a combination pattern of Triple Top Breakout and Double top Breakout. It has following characteristics:

1. First, a Triple Top Breakout happens.

2. Next comes the pullback (reversal), producing rising O’s.

3. Following the pullback, the stock resumes the trend and a Double Top Breakout happens.

In the above stock data of Facebook, the Bullish Catapult pattern is formed. Let’s try to understand above pattern in pieces.

First, a Triple Top Breakout pattern was formed (with rising O’s), predicting further rise in prices. Prices rise significantly and thereafter reversal in O Column happened. Long-term traders can utilize this reversal (after Triple Top Breakout) to enter in a long trade with half of the quantity.

Once the stock reverses again (in X Column) and gives a Double Top Breakout, this confirms the formation of Bullish Catapult. Long-term traders can buy remaining half of the quantity on the formation of Bullish Catapult. Compared with other patterns, this pattern is more reliable and usually the price moves faster once this pattern is formed.

## How the Bullish Shakeout Formation is a combination of bearish and bullish pattern

This is a bullish pattern formed through a combination of a bearish and bullish pattern having characteristics:

1. Stock must rise to a level where it forms two tops at the same price. Please note that is should just form two tops (at the same price) and not the breakout.

2. The subsequent reversal of the stock from these two tops must form a Double Bottom Breakdown.

3. The subsequent reversal of the stock from Double Bottom Breakdown must form a Triple Top Breakout.

In the above stock data of Facebook, Bullish Shakeout pattern is formed. Traders can buy half of the quantity once stock reverses to column X from Double Bottom sell signal. Remaining half of the quantity can be bought at the time of Triple Top Breakout. Like Bullish Catapult pattern, this pattern also produces greater results in least time.

## How Broadening Top Formation happens before a Double Bottom Sell

This is similar to a Bullish shakeout pattern with one minor variation – a Double Top Breakout happens before a Double Bottom sell signal is given.

In this Facebook stock data, broadening top pattern is formed. Traders can buy half of the quantity once stock reverses to Column X from Double Bottom sell signal. The remaining half of the quantity can be bought at the time of Double Top Breakout. Like Bullish Catapult and Bullish Shakeout patterns, this pattern also produces greater results in least time.

Amit Pal

Product Analyst