Using P&F Charts to Find Price Targets

In a recent article, we highlighted the usefulness of point and figure (P&F) charts. This week we revisit the charts and explain how they can be used to find precise targets. That can help traders determine whether the potential rewards of a trade are acceptable, given the level of risk involved.

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  • Rather than reviewing the construction and fundamentals of the P&F chart, we would refer readers to the previous article which can be found here. In this article, we will describe two techniques for determining price targets.

    Both techniques are based on the concept of symmetry, a principle that technical analysts find at the core of many chart reading techniques. For P&F charts, analysts assume that price moves will show a high degree of symmetry. This allows them to project a target as soon as a setup is completed.

    Horizontal Counts

    The first technique we will cover is the more common one, the horizontal count. This technique is applied after prices break out of a consolidation. A consolidation is a trading range where the price makes little up or down progress for an extended period of time. An example is in the chart below.

    Source: StockCharts.com

    This is a chart of the iShares Russell 2000 ETF (NYSE: IWM). The most recent stock market trading range is highlighted by a blue rectangle. Remember that P&F charts ignore time but the letters and numbers on the chart indicate time. This trading range began in December 2016 and a breakout occurred in September.

    To find a price target, we count the number of columns that are filled in to form the trading range. In this case, the range is seven columns wide. To verify this, count the number of symbols in the row directly below the number 2 that is shown in red.

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  • In this chart, each box represents a $2 move. This is the parameter of the box size. To find the expected size of the price move after the breakout, we multiply the width of the pattern by the box size, or 7 times $2 in this chart. That tells us to expect a $14 up move from the breakout level.

    In this chart, the breakout occurred at $140, the price level where a triple top buy signal was given. If you’re new to P&F charts, again, now would be a good time to review our previous article which can be found here. That could help make the terms used in this article more clear.

    The final step in the process is to add the size of the expected price move to the breakout level, providing a price target of $152 for IWM, which is $140 + $12. That’s all there is to finding targets with the horizontal count technique. The process can be expressed in two formulas:

    1. Width of pattern * box size * reversal size = A
    2. A + high of consolidation pattern = target

    For a downside break out of a consolidation pattern, the process is similar. The first step is the same as for up side break outs. The second step involves subtracting the objective from the low of the pattern. This is summarized below:

    1. Width of pattern * box size * reversal size = A
    2. Low of consolidation pattern – A = target

    This is the basic technique. There are variations that are more aggressive or more conservative but all involve finding the size of the expected move and adding or subtracting that from the consolidation pattern.

    Vertical Counts

    The vertical count can be a little more confusing to find. We will use the chart below to explain the process.

    Source: StockCharts.com

    The vertical count uses the column of Xs or Os that forms after the breakout. This technique requires waiting for the breakout and a subsequent reversal to determine the price target. In the chart above, the initial consolidation is marked by the letter A.

    The blue arrows highlight the breakout column. The section marked B verifies that the column marked by arrows is a breakout column. This is called the reversal column.

    After the reversal column is formed, the price target can be found. The first step is to count the number of Xs in the breakout column. This is then multiplied by the box size and the product of that multiplication is then added to the low of the reversal column.

    Once again, we understand that this technique can be confusing so we would like to break down the technique using the chart above as an example.

    1. After the initial breakout, wait for column of Xs to reverse to Os.
    2. After the column of Os appears, count the number of Xs in the previous column. In the chart above, there are twelve Xs in the column. Numbers and letters signify time and should be considered to be Xs for this technique.
    3. Find A with the following formula: A = height of count * box size * reversal size. This chart uses a box size of $2 and a reversal size of 3. The height of the pattern is 12 so the formula is 12 * 2 * 3 = 72.
    4. To find the price target, add A to the low of the reversal column. In the chart above, the low of the reversal column is at $132. The price target is $132 + $72 or $204.

    The price objectives found with the vertical count technique provide long term targets. In this case, IWM has a short term target of $152 and a long term target of $204. This indicates there is a significant amount of potential up side in the current bull market.

    For a downside break out, the steps are similar:

    1. After the sell signal, wait for column of Os to reverse to Xs
    2. After the column of Xs appears, count the number of Os in the previous column.
    3. A = height of count * box size * reversal size.
    4. Target = high of reversal count – A.

    These two techniques are useful and can be applied to any stock, ETF or market index.

    Analyzing SPY

    SPDR S&P 500 ETF (NYSE: SPY) is an ETF that tracks the S&P 500, one of the most widely followed stock market indexes. The chart of this ETF is shown next.

    Source: StockCharts.com

    Here, the story is less bullish. SPY is extended and has already reached its price target of $254. That indicates a pull back in the broad stock market should be expected. In the long term, the vertical count technique provides a target of about $275, so there is significant up side potential after the pull back.

    While these techniques are useful, they are not the only tool that an analyst will need. They are just one tool in the technical analysts’ toolkit. One weakness of this technique is apparent with the chart of SPY. Although the target has been reached, the counts tell us nothing about how deep the pull back is likely to be.

    The chart does show support near $234. This could stop a pull back and indicates the pull back could be about 8%. However, other techniques like traditional chart analysis should be used to confirm that price target.

    P&F charts are, of course, just one indicator that analysts apply to charts. Another indicator, one with a proven track record of success, is the cornerstone of Stock Trading Tips PPK System. You can learn more about this trading service by clicking here.