Point and Figure Charting

The Essential Application for Forecasting and Tracking Market Prices

Thomas J. Dorsey

• Publisher: Wiley
• Year: 2013
• Print ISBN: 9781118445709
• eBook ISBN: 9781118799369
• Edition: 4
• Topic: Business
• Subtopic: Finance
• Index: Business

An up-to-date look at point and figure charting from one of the foremost authorities in the field

If you're looking for an investment approach that has stood the test of time—during both bull and bear markets—and is easy enough to learn, whether you're an expert or aspiring investor, then Point and Figure Charting, Fourth Edition is the book for you. Filled with in-depth insights and expert advice, this practical guide will help you grow your assets in any market.

In this reliable resource, the world's top point and figure charting expert, Tom Dorsey returns to explain how traders and investors alike can use this classic technique—borne out of the irrefutable laws of supply and demand—to identify and capitalize on market trends.

• Describes, step-by-step, how to create, maintain, and interpret your own point and figure charts with regard to markets, sectors, and individual securities
• Explains how to use other indicators, including moving averages, advance-decline lines, and relative strength to augment point and figure analysis
• Reveals how to use this approach to track and forecast market prices and develop an overall investment strategy
• Skillfully explains how to use point and figure analysis to evaluate the strength of international markets and rotate exposure from country to country

Today's investment arena is filled with a variety of strategies that never seem to deliver on what they promise. But there is one approach to investment analysis that has proven itself in all types of markets, and it's found right here in Point and Figure Charting, Fourth Edition.

PART I

LEARN THE POINT AND FIGURE METHODOLOGY

CHAPTER 1

Introduction

■ Point and Figure Charting: A Lost Art

I would never have thought we would be embarking on the fourth edition of this book when I wrote the first edition. I know now that this will not be the last edition either. Technology has significantly changed the way we approach technical analysis and the way we implement the art of portfolio management. The Internet has provided a delivery system we could not have imagined when I was a stockbroker at Merrill, Lynch, Pierce, Fenner & Smith in the 1970s. What I mean by that statement is that computers can now do most of the work for you. We have taught the computer to do exactly what we used to do by hand 25 years ago. The operative word there is taught. The computer can only do what we tell it to do. Somewhere in the future it might do its own thinking, but at this writing, it has to be told. Think about medical technology for a second. I have a friend who is going to be operated on next week by a robot. To me this is The Jetsons revisited. The Jetsons was an animated sitcom that debuted in 1962. It was about a Space Age family living in the future (the exact opposite of the animated sitcom The Flintstones, which was a family living in the Stone Age). Much of what was depicted in that weekly show has come to pass. Think of how automobiles can now parallel park by themselves. Robots can perform operations on humans but only under the eye of a trained surgeon. We have gotten to the point where a surgeon-guided computer can actually perform the operation with more skill than an unassisted human, just like computers can outplay world-class chess players as “Big Blue” did against Gary Kasparov and later the computer “Watson” outplayed the best contestants on the TV game show Jeopardy. The computer does exactly what it is told with no emotion and no mental or physical fatigue (if you don't think mental and physical fatigue come into play with regard to portfolio management, think again). Google has transformed how we deal with ordinary medical conditions that used to require us to see a doctor for advice. Today, most people simply “Google” the symptoms and thousands of informational pages instantly appear. It still amazes me. Naturally, if the online remedy didn't work, you would go to your doctor, but only after you searched the Internet for a solution. Investing is the same today. On our system you could search for, say, a list of high-dividend stocks in the Oil Service and Utility sectors. Then you could simply click a button and the DWA Matrix system would perform an extensive “relative strength arm-wrestling contest” among all the stocks, and then order the list from best relative strength to worst relative strength in the group. It would only take a matter of minutes to perform these tasks. Then an investor could click a button to buy at the market the top 5 or 10 on the list. After that, a program could be set to sell any stock that dropped to a certain level on that relative strength list and replace it with a purchase of the next strongest stock. Think I'm kidding? The technology is already here at Dorsey, Wright & Associates (DWA). It is amazing to me that we have this capability relative to where we were only 10 years ago. In a matter of minutes you could create a good income-producing portfolio ready for investing. But without reading this book carefully, you would not understand the underlying concepts used in this computer search. This book is the first rung of the ladder on your climb to becoming a world-class investor. Questions you will learn to answer before you take full control of your investments include:

• Which asset classes are in favor?
• Did you search the right sector?
• Is the market in a mode to support higher prices?
• What countries are the best places to invest?
• What mix of bonds and stocks should you have in your portfolio?
• Should you use stocks, exchange-traded funds, or mutual funds to populate your portfolio?

There are many questions that need to be answered to stack all the odds in your favor, but once they are answered, let technology do the driving. You see, you are still an integral part of the equation. This goes for professionals and individual investors alike. There are two kinds of investors—those who want to use the quarter-inch drill and those who simply want the quarter-inch hole. Harvard marketing professor Theodore Levitt illustrated this difference with this straightforward analogy: “People don't want to buy a quarter-inch drill. They want a quarter-inch hole!” You know what? I so believe in the quarter-inch hole concept that I had my niece Meghan Hartsoe, who is an artist, paint me a black hole on a canvas—nothing else but a creatively drawn hole. I want Dorsey, Wright Analysts to always keep this concept in their minds as we write research and develop new products to serve the investment advisory business.

Over the years, we have all experienced many medical difficulties and have learned from them. When we have a cold, we automatically know what over-the-counter medication to take for it. If we have a scratch that becomes infected, we know exactly what to do for it. We have many years of hands-on knowledge about simple health problems we all encounter on a daily basis. In the investing world, you don't have these basic life skills we acquire just by being alive. You have to learn them. What were the telltale signs that 2008 was going to be a terrible year for investor portfolios? How did anyone know that the banking sector was in deep trouble and the stocks underlying it were about to fall? You certainly didn't learn it from the financial newsprint or financial TV. If investors could learn anything from reading or watching these forms of media designed to give investors a heads-up, there would not have been 13 trillion dollars of American household net worth lost in the meltdown. These are the things you will learn in this book that will eventually become intuitive to you. When you have a working knowledge of the material in this book, you will then be ready to let the computer do the work. Just like doctors let robots do the work today and airline pilots allow planes to land with no human assistance, you, too, will be ready to let technology do the work and have it delivered to you on your mobile device. One of the largest deterrents to successful investing is encapsulated in one word: emotion. Computers don't have emotion; they only do what they are told to do. They don't watch CNBC or read the Wall Street Journal.

In learning this method it is always best to maintain some charts by hand. Nothing will give you a better feel for it. Even though the computer is updating the same chart automatically, when you put that one extra “O” in the chart as you update it by hand, and that “O” completes a certain pattern you know has statistical significance, it's an “aha” moment you won't forget. So, yes, it is important to learn the craft before you allow the computer to take over. Take the time to read this book carefully, underline, take notes, take it page by page, and in the end you will be well rewarded. Remember, “life's a cinch by the inch; life is hard by the yard.” I live by this saying, and it's how I will complete this book. At the end of the financial accumulation road, the goal is to have more money than when you started on that road. This is financial planning. I have often said the best financial plan is a stock that goes up. Over the years, we have been able to develop new and interesting ways of implementing Point and Figure analysis. But you know what? Nothing has changed in the basic principles of this method in 140 years. Here's why. The irrefutable law of supply and demand has not changed since first introduced in the caveman days. If you understand and embrace the concept of supply and demand, you are at the right place.

When we first started DWA, we used a Tandy 3000 computer that was considered to be state of the art. We did not have enough money to buy it outright, so we leased it. When it was all totaled, that computer cost $3,000 in rent. That was probably twice the cost of buying it. My guess is today this computer would be in the Smithsonian Institute if it were still around. It performed only a small fraction of the tasks computers perform today. I'm writing this on a computer that cost $400 and has more computer power than the astronauts had when they reached the moon. Twenty years ago, there was no such thing as an online charting system. It was around 1994 when we went live with our Internet-based portfolio management and charting system. We updated 2,500 stock charts by hand for close to a decade. Our relative strength charts were updated by hand once a week. It was a rite of passage for each intern to maintain the relative strength charts each week. Distribution of our research each day was done by fax machine. The machine we used to fax out our 20-page report each day cost $1,800. This fax machine was state-of-the-art technology, and we borrowed it from friends. Since we had no money, only debt in the beginning, we had to go downstairs to another company that magnanimously loaned us the use of their fax. Each day we faxed out our report by hand, page by page. This machine could fax to only one phone number at a time. This was in 1987. I think we paid seven cents a page to use this fax. I can't quite remember the cost. When you start a business with nothing, you do whatever it takes to make it work. By 1994, we were on the Internet; however, our clients were not up on that technology curve yet and still wanted our reports by fax. This is a great example of the “technology gap.” Those who wanted to take down stock charts did so through the outdated DOS (disk operating system) system. Today, in 2013, it feels like we are working with Star Wars technology. I am continually amazed by what we can teach the computer to accomplish. I am continually amazed because I am among the few today who can remember the first computer programs written for public use back in the 1960s. People today grow up with technology I did not. Maybe this is why I feel like I'm living in a fantasy world. Today, the iPad 4 was released. Amazing! Remember when you used eight-track tapes in your car to listen to music? Heck, I remember a friend in high school who had a 45 rpm (revolutions per minute) record player in his car, attached to springs to keep it stable. We use to bring stacks of 45 records to play as we drove around in his little Spitfire sports car in Germany where I went to high school. This was technology at its best. How could it get any better than that? Most of you reading this are far too young to remember the in-car record players, but you do remember the CD. People use CDs today, but they are yesterday's technology. What most of you use is iTunes. iTunes allows you to download music from the Internet. I'm not telling you anything new here. I'll bet most of the cars you drive still have the CD sound system. More than likely you kept using the CD for a while before you adapted to music download on the Internet. Most of us will hold on to the old way of doing things until we are forced to switch. It's more comfortable to stick with the old because we're familiar with it. This is the technology gap I keep talking about. I want to keep that concept firmly in your mind because this book will teach you some things that are disruptive to your way of looking at the stock market. We all have preconceived ideas on how the market is supposed to work. Get ready for a ride that will take you “back to the future.” Rest assured, technology never sleeps. It keeps advancing, and you too must keep advancing to stay up with it. Examples of the technology gap are everywhere. I remember one of the largest brokerage firms on Wall Street saying the Internet was a “flash in the pan,” and they were not putting any significant resources into it. Incidentally, this firm went bankrupt and had to be bought by a major bank in 2009. We knew from the start how important this new technology would be and put all our resources into it. With this new technology, we were able to deliver our product to a much larger population of investors. The Internet did not change what we were already doing—it just facilitated the delivery of it. It was the massive leaps and bounds in computer technology in general that allowed us to push past the boundaries of Point and Figure analysis as it had been known for 100 years prior. We were able to create new and important indicators that stemmed from the basic Point and Figure analysis simply because of the speed of calculations. Productivity is about doing more with less. As computers became more efficient and faster, the Internet allowed us to deliver our product almost instantaneously to anyone, anywhere in the world. Take, for instance, the speed of calculations today. This speed allows us to compare and contrast on a relative strength basis millions of charts overnight. Think about this for a second. It took us a week to update 200 relative strength charts 25 years ago. Until April 2012, we had the capability of updating millions of charts overnight. Today, we can do the same number in 10 minutes using “cloud technology.” We now, almost instantaneously, follow the world. To Dorsey, Wright, the world is open for business. We continue to push the envelope with technology, and every few years we have new and innovative things we have created to help investors and professionals become more successful at the investment process while at the same time we give them their life back. Much of what professional advisers used to do can be done by computer today. This is why I am sure that at some point in the future there will be a need for Point and Figure Charting, Fifth Edition. For now, we have more than enough new things to discuss in the fourth edition.

■ Beginning with the Basics

Let's start with the basics of how this stock evaluation and portfolio management system was developed. The Point and Figure method is not new by any stretch of the imagination. It is, however, a lost art simply because most investment professionals and individua...

Table of contents

• Cover
• Half Title
• Series Page
• Title Page
• Copyright Page
• Acknowledgments
• Part I: Learn the Point and Figure Methodology
• Part II: The Point and Figure Methodology— A Complete Analysis Tool
• Part III: Apply the Point and Figure Methodology to Your Investment Process
• About the Web Site
• Index