The distinctive alternating columns of X's and O's that make up a point and figure chart clearly differentiate this technique from other more widely used forms of technical analysis. Yet, the most startling aspect for someone more used to line, bar or candlestick charts is the absence of a time axis. By recording price changes and not the passage of time, point and figure is able to reveal certain chart characteristics that would otherwise remain hidden.

Point and Figure (P&F) originated in the United States in the 1880s and is reportedly the oldest charting technique, predating bar charts by approximately 15 years or so. A P&F chart combines price movements into either a rising column of X's or a falling column of O's. These columns alternate with each other and can be thought of as up trends and downtrends, respectively.

Each X or O occupies what is known as a box on the chart. A setting called the box size determines the amount that a price needs to move above the top of the current column of X's or below the bottom of the current column of O's before another X or O is added.

The most appropriate box size depends on what is being charted and the relevant time frame. A useful rule of thumb is to use 1% of the range of prices rounded to a convenient value. For example, if the relevant back history of a stock had a high of 500 cents and a low of 200 cents, the high-low range would be 300, making the 1% box size equal to 3 cents.

Each P&F chart also has a second setting called the Reversal Factor. The box size multiplied by the reversal factor determines the amount that a stock needs to move in the opposite direction (down if currently in a rising column of X's, or up for a column of O's) before a reversal occurs. When this happens, a new column is started to the right of the last one. In this way, the chart builds up with alternating columns of X's and O's.

As long as a security is in an up trend, and it doesn't move down more than the reversal amount (box size multiplied by the reversal factor), the P&F chart will show a growing column of X's. Equally, a stock in a downtrend will cause a descending column of O's to appear until such time that the security ticks up by the reversal amount.

The combination of the reversal factor and the box size acts as a filter on the price movements and determines the level of detail shown. By eliminating insignificant price movements, or noise, P&F charts can be much clearer than other types of charts.

Reducing the reversal factor, like reducing the box size, increases the sensitivity of the chart, but traders looking to do this should keep the reversal factor set to 3 and try reducing the box size first. The reason for this is that a reversal factor of 3 means that, by definition, the minimum column height will be three X's or O's. This makes the chart easier to visually interpret than a plot based on a reversal factor of just two.

P&F charts are only scaled on the vertical price axis. When a new column of X's or O's is recorded, it says nothing about the passage of time but, rather, that a reversal has occurred. A column can take minutes, hours or days to form; it all depends on the extent of the price movement.

One of the most straightforward P&F formations is the double top. This pattern follows a rising trend and occurs if the price advances to a high before declining and then rising back to the previous high.

On a P&F chart, this will appear as two columns of X's culminating at the high and standing out above the other data. Once the double top is established, it is the subsequent price behavior that determines whether there is a trading opportunity.

P&F also makes many patterns and developments that are visible on other chart types more easily recognizable. One example of this is a congestion area. These are harder to recognize on a bar chart, especially if they have formed over several months, because the pattern gets stretched horizontally by the passage of time.

The way a P&F chart is constructed also makes support and resistance levels really stand out. A support level appears as a horizontal row of O's that mark the bottom of each of their respective columns while a resistance level is a horizontal line of X's joining the top of the alternate rising columns. The unitized scale based on the box size also makes it very apparent when a support or resistance level is broken because the established price will be breached by one or more X's or O's.

*The full version of this article was first published in Traders' magazine and is reprinted (and modified) with permission from Nick Sudbury.