Point and Figure Charting: A Lost Art
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 individual investors have lost sight of the
basics that cause fluctuations in the prices of securities. In
today's rapidly evolving technologies, the irrefutable law of supply
and demand has been all but forgotten. In the end, the only
thing that will outlive technological change and that is truly sustainable
is the transcendent competence of an individual's workmanship.
New methods of security analysis continue to crop up
capturing the ever-expanding curiosity of the investment public.
It seems everyone is searching for the Holy Grail, yet few are willing
to become a craftsmen at the investment process. So many are
looking for a computer program that will define the winning
trades each day without any effort from the investor or professional
who has ultimate responsibility for the portfolio of stocks.
A long time ago when I was a stockbroker at a major firm on Wall
Street, I learned there is no Holy Grail. The key to success in this
business, and any business for that matter, is confidence. According
to my dictionary, confidence means "firm belief or trust; self-reliance;
boldness; assurance." In the securities business, the key
term in the definition is self-reliance, and it is the one trait most
investors and stockbrokers lack. Investors today are increasingly
averse to making their own decisions, which is why the mutual
fund business has grown to record levels. Those who have taken
control of their own investments have done so without much in
the way of training and education in the investment process. The
irony is that 75 percent or more of professional money managers
never outperform the broad stock market averages. Nevertheless,
most investors look at the stock market as an enigma. It confounds
them that the market reacts in what seems to be an illogical
pattern. Increased earnings expectations should result in price
appreciation of the underlying stock, right? Not necessarily. In
many cases, the opposite takes place. In the year 2000, we saw exactly
that. Stocks with great fundamentals collapsed under their
astronomical valuations. Companies like Lucent Technologies
declined from 80 to the single digits. Major firms on Wall Street
were in love with the stock's fundamentals at 80. Lucent's only
problem was not in the company itself but in its customers' ability
to pay for the products they had purchased from Lucent. This
information did not show up in the fundamental research until
the stock had collapsed. It did, however, show up in the Point and
Figure chart. Those who were well versed in evaluating the supply-demand
relationship of the stock saw trouble early on.
Now it is the year 2001, and over the past six years my confidence
in this methodology has increased tremendously. While
nothing in the method has changed an iota, how we use it has expanded
and grown. We have developed some new indicators,
many based on the Bullish Percent and Relative Strength concepts
covered in the first edition, and have found new ways to use
many of the old indicators.
In the past five years, we have gone through some of the most
volatile markets anyone has seen. Negotiating the markets in
this volatile and changing economy points up the need for an operating
system to guide investors. This book provides that operating
system. The old paradigm of buying quality stocks with
real products and visible earnings has gone right out the window.
At least the media and most investors think so. In the late 1990s,
the mantra on Wall Street was, forget earnings they aren't important,
only revenues are important. We heard 22-year-old CEOs
suggesting that the old line companies, the backbone of the
United States, "just don't get it." Well, the crash of the dot-com
companies that thought they "got it" has awakened Americans
to a market that both gives and takes away. At this writing, the
22-year-old CEOs "didn't get it." Investors have come to realize
that real wealth is made in the stock market. They have also
come to realize that the market can take it away just as fast. Attention
to the bottom line is now back in vogue as investors recognize
that net earnings are in fact important. In the latter part
of the 1990s, firms attempted to create brand names by simply
throwing millions of dollars into advertising. Companies were
trying to create solid brand names in one month that took companies
like Procter & Gamble 40 years to create. Some companies
even sell products below cost, with the expectation of
making up the difference in advertisement revenues.
This all came to roost in the second quarter of 2000 when the
Nasdaq stocks literally melted down in a matter of a few weeks.
All of a sudden, the market that once valued The Street Dot Com
(TSCM) at 71 now valued it at 3. Microstrategy (MSTR) once
traded as high as 330 and at this writing has fallen to 14. The
highflier Priceline.com was as high as 165 and is now 5. How
quickly the market corrects overexuberance, as Alan Greenspan
warned. The highfliers were not the only ones that were hit in
2000; some stocks, many New York Stock Exchange names, hit
their peaks in 1998 and are just beginning to show signs of life
again. Quality companies like Eastman Kodak, Cisco Systems,
Polaroid, Procter & Gamble, AT&T, Worldcom--the list goes on
and on--have seen their stock prices cut in half or worse. There
was basically nowhere investors could hide. It was an interesting
market from April 1998 to March 2000 in which the indexes did
fairly well while the stocks underlying them were killers. This
happens when an index is controlled by a handful of stocks like
the Dow Jones, Nasdaq, and the S&P 500. It is so easy for an index
to be pushed and pulled by the top tier stocks while the vast majority
of stocks underlying the index are struggling at best.
You know what concept never wavered once during this
treacherous period? It was the irrefutable law of supply and demand.
In almost all the cases cited, the charts foretold trouble
down the road. In later chapters, I point out how these supply-and-demand
indicators "saw" this crash coming and told us the
risk was high. We were then able to get our clients out of harm's
way. We have once again gone through a market condition never
seen before. The Internet has injected change into the whole
game on Wall Street. Barriers to entry to dot-com businesses are
nil on the Net, and that freedom brings tremendous competition.
The playing field is being leveled every day. The one constant
that has not changed in over 100 years is supply and demand and
the Point and Figure method of analyzing markets.
What Do Investors Today Have in Common with 18-Year-Old Bungee Jumpers?
The answer is, no fear. Over the past decade, investors came to
believe that buying the dips is the key to success: Stocks always
come back, don't panic, just buy more. Some people leveraged
their homes to put money in the stock market. This kind of situation
never ends well, and in the year 2000 it didn't. The crash in
Nasdaq stocks caught just about everyone off guard, and massive
losses were generated buying the dips, averaging good money
after bad. I don't believe investors have broken this habit yet, but
they are certainly bowed.
The "buy every dip" mentality is what I call false courage.
False courage is confidence you may feel when under the influence
of alcohol or drugs. It dulls the senses and gives you the confidence
to do things you otherwise would not consider. A friend
of mine, Cornelius Patrick Shea, used to say, "My pappy use to
tell me the 'sauce' makes ya say things ya don't mean and believe
things that ain't true." The "sauce" for investors consisted of the
seemingly never ending rise in highflying tech stocks. It was so
intoxicating that investors were "saying things they didn't mean
(buy 1,000 more) and believing things that weren't true (revenues
are increasing with no end in sight)." During the latter part of the
1990s and first quarter of 2000, investors were enamored with the
seemingly never-ending ascent of the stock market and in particular
the Nasdaq. The media aided this belief with the ceaseless
chant of zero inflation and endless increases in worker productivity
due to technological advances. Because of their intoxication,
investors kept taking more risks through leverage in high volatility
stocks beyond any rational measure. I even had a broker call
me up with a story of how her aunt was not allowed to use margin
at her firm because of her advanced age (she was 80). Do you
know what she did? She took a second mortgage out on her
house, put it in her stock account, and continued trading. In
essence, she skirted the brokerage firm's margin requirement and
margined the account anyway. I wonder how she fared after the
crash of March 2000, May 2000, and November 2000? She may
have lost her house.
Many investors have forgotten that having a logical, organized,
well-founded method of investing in the markets is the only
way to success. Haphazard, overleveraged, methodless investing
will always lead to disaster, just as it did in 2000. The Nasdaq not
only corrected, it headed south like a migrating bird. Its decline
was so swift that, in a matter of weeks it had lost 37 percent from
its high, and that even masked what happened to so many stocks.
Many individual stocks lost 80 percent or more of their value. Investors
with a whole portfolio of high-tech/high-wreck Internet
and technology stocks may not see the light of day in their accounts
for many years to come. The average gain in the stock
market over the past 80 years is around the 10 percent level. If an
investor loses 50 percent of his portfolio value, that portfolio will
have to rise 100 percent to get back even. How long will that take
at an average 10 percent per year? About seven years. If an investor
bought at the top in 1973 and rode the market down, it
took 7 1/2 years to get back even. Can you wait 7 1/2 years to get your
money back if you ride a bear market down as the media and mutual
funds suggest you should do? If your answer is no, then you
are ultimately interested in risk management, which is what this
book is all about.
I was in a store the other day purchasing a new laptop computer
to write this book. I got into a conversation about investing
in the market with the head of the computer department. He was
having a hard time understanding what I did. I told him that successful
investing requires an operating system like the one in
every computer. The computer's operating system allows it to effectively
read and run all the software products. Operating systems
like Windows 98 simply provide a set of instructions that
tells the computer how to run. Without an operating system, software
cannot run on the computer. Investing is the same. Investors
must have an operating system firmly in mind to work from, before
they can accomplish anything.
This operating system is the core belief in some method of
analysis an investor both understands thoroughly and embraces
wholeheartedly. It's like getting religion on Wall Street. At some
point, all successful investors have to find some church on Wall
Street that they can attend every week. Many investors subscribe
strictly to the fundamental approach of investing. This method
only delves into the internal qualities of the underlying stock. It
does not take into consideration timing entry and exit points in
that stock, and above all, supply and demand imbalances. Other
methods of analysis might involve astrology, Fibonnaci retracement
numbers, Gann angles, waves, cycles, candlestick charts,
bar charts, or any other method you are willing to embrace. At
Dorsey, Wright, we only subscribe to one irrefutable method--the
law of supply and demand. If you want to go back to the basics,
with a methodology that has stood the test of time, in bull and
bear markets, and is easy enough to learn whether you are age 8 to
80, then you are reading the right book. This operating system
will carry you through your investment endeavors, from stocks
and mutual funds to commodities.
Why Does This Method Make Sense and Where Did It Originate?
We humans have certain limitations when coping with rapid decision
making. Most investors find it difficult to think through
the complex decisions they need to make about equities. The
problem is not that we have too much information. The problem
is managing and processing this information. It is like a fire hose
of information that hits us in the face every day. The question is
how to control that massive information flow and break it down
into understandable bits that we can use to make effective decisions.
In essence, we have decision overload.
To help you organize this information, we have some powerful
tools (see our Web site: www.dorseywright.com). The simplest
example of how information is organized is the telephone. We
have an ability to remember three or four numbers in succession
easily but seven is difficult. This is why our phone numbers are
divided up in threes and fours. The pound sign and the star sign
on the phone were there for years with no apparent function.
Now we routinely use them. They had no function when they
first appeared on phones, but the phone companies knew that
eventually there would be a use for them in managing information.
Similarly, Charles Dow found a way to organize data back in
the 1800s. He was the first person to record stock price movement
and created a method of analysis called Figuring that eventually
led to the Point and Figure method described in this book.
The Point and Figure method of recording stock prices is simply
another way of organizing data.
At the turn of the twentieth century, some astute investors
noticed that many of Dow's chart patterns had a tendency to repeat
themselves. Back then, there was no Securities and Exchange
Commission; there were few rules and regulations. Stock pools
dominated the action and outsiders were very late to the party. It
was basically a closed shop of insiders. The Point and Figure
method of charting was developed as a logical, organized way of
recording the imbalance between supply and demand. These
charts provide the investor with a road map that clearly depicts
that battle between supply and demand.
Everyone is familiar with using maps to plan road trips. When
we drive from Virginia to New York, we start the trip on I-95
North. If we don't pay attention to our navigating and inadvertently
get on I-95 South, we are likely to end up in Key West,
Florida. To prepare for a journey with your family to New York
from Virginia, you need to familiarize yourself with the map,
check the air in your car's tires, begin with a full tank of gas, and
make sure the children have some books and toys. In other words,
plan your trip. Most investors never plan their investment trip.
The Point and Figure method of analyzing supply and demand can
provide that plan. Nothing guarantees success, but the probability
of success is much higher when all the possible odds are stacked in
the investors' favor. Somewhere along the road, you may be forced
to take a detour, but that's okay as long as you stick to your original
plan. This book will outline the best plan for financial success
when you are investing in securities.
When all is said and done, if there are more buyers in a particular
security than there are sellers willing to sell, the price will
rise. On the other hand, if there are more sellers in a particular
security than there are buyers willing to buy, then the price will
decline. If buying and selling are equal, the price will remain the
same. This is the irrefutable law of supply and demand. The same
reasons that cause price fluctuations in produce such as potatoes,
corn, and asparagus cause price fluctuations in securities.
Two methods of analysis are used in security evaluation.
One method is fundamental analysis. This is the method of
analysis familiar to most investors. It deals with the quality of
the company's earnings, product acceptance, and management.
Fundamental analysis answers the question what security to
buy. Technical analysis is the other basic method. It answers the
question when to buy that security. Timing the commitment is
the crucial step. Fundamental information on companies can be
obtained from numerous sources. There are many free Internet
sites that deal strictly with fundamental analysis. The technical
side of the equation is much more difficult to find because few
securities professionals are doing quality technical analysis that
the average investor can understand. This book is designed to
teach you how to formulate your own operating system using
the Point and Figure method, coupled with solid fundamental
Why You Should Use Point and Figure Charts
Although the investment industry is overloaded with different
methodologies to evaluate security price movement, the Point
and Figure method is the only one I have found to be straightforward
and easy to understand.
The charts are made up of X's and O's. Recording the movement
of a security using this method is very much like recording
a tennis match. A tennis match can last 12 sets. Each player can
win a certain number of sets, but the final count determines
which player wins the match. In the Point and Figure method, we
are only interested in the culmination of the match, not the winner
of the underlying sets. The patterns this method produces are
simple and easy to recognize--so simple that I have taught this
method to grade schoolers in Virginia. I have always maintained
that simple is best.
The concept underlying the method must be valid. Supply and
demand is as valid and basic as it gets. I am not criticizing the validity
of other methods; it's just that most people can easily understand
supply and demand because it is a part of everyday life.
Why not make it a part of your everyday investing?
The greatest market indicator yet invented was developed by
A.W. Cohen in 1955. It is called the New York Stock Exchange
Bullish Percent Index. We have used it for many years with great
success. In that time, we have refined it as the markets have
changed, but the basic philosophy is still intact. I have devoted a
whole chapter of this book to a discussion of this indicator. Our
sector rotation method, which is explained in another chapter, is
a derivative of the Bullish Percent concept. Once you learn these
basic principles, your investing confidence will increase tremendously.
You will soon find yourself acting rather than reacting to
different market conditions. This method changed my life, and it
can do the same for anyone who takes the time to read this book
and then implements the investing principles contained therein.
In the Beginning
It took me years of operating in a fog in the brokerage business before
I came across the Point and Figure method. I started my career
at a large brokerage firm in Richmond, Virginia, in late 1974.
When training new employees, the firm focused primarily on
sales. As trainees, we were drilled in the philosophy that the firm
would provide the ideas and our responsibility was to sell them.
The first four months at the firm we devoted to study. Every potential
broker must pass the Series 7 examination to become registered
with the New York Stock Exchange. The course was
extensive--covering everything from exchange rules and regulations
to complicated option strategies. Once we had passed the
exam and completed five weeks of sales training, we were ready
to be unleashed on the public.
As in any other profession, experience counts a lot, and we
were severely lacking in that area. The market had just gone
through what seemed to be a depression, losing about 70 percent
of its value. Prospecting for new accounts was a difficult task at
best, but those of us who survived spent the next four years building
a book of business and learning by trial and error. Each morning,
we had mounds of new recommendations from New York to
sift through, all fundamental. We were not allowed to recommend
any stocks our firm did not have a favorable opinion on; the
rule was no thinking on our own--it could cause a lawsuit. Our
job was to sell the research, not question it.
Over the years, we had some tremendous successes and some
spectacular failures, definitely not a confidence builder. In my
spare time, I kept searching for some infallible newsletter writer.
This search, however, only proved that the newsletter writers
were better at selling newsletters than at picking stocks. The ship
was basically rudderless, but we forged ahead. Now, almost 21
years later, nothing much has changed in the way business is
done. There are some new bells and whistles and fad investments,
but the backbone of the industry continues to be equity recommendations
based solely on fundamental analysis. During my
tenure at that firm, I specialized in option strategies. Options
were relatively new, having been first listed for trading in April
1973. I spent much of my time studying this investment tool, and
in 1978 I was offered the opportunity to develop and manage an
options strategy department at a large regional brokerage firm
home-based in the same town. It was an irresistible challenge, so
I embarked on this new adventure.
Overnight, my clientele changed from individual investors to
professional stockbrokers. I was now responsible for developing a
department that would provide options strategy ideas to a sales-force
of 500 brokers. At this moment, I had to be totally honest
with myself. Just how much did I really know about the stock
market? I knew that my success at selecting the right stocks to
support our options strategies would ultimately determine the
success or failure of my department. The answer to that question
After four years of working as a successful stockbroker, I had
very little knowledge about selecting stocks on my own, much
less evaluating sectors and the market itself. I was used to doing
what the firm directed. The one thing I did know was that relying
on any firm's research was likely to be hit or miss. Developing a
successful options strategy department meant I would have to
find someone who was adept at stock selection.
During my search for a stock picker, one name continued to
crop up: Steve Kane, a broker in our Charlotte branch. I contacted
Steve and explained my new adventure to him and offered him a
position in my department. He decided to join me. My grand plan
was that Steve would provide the stock, sector, and market direction;
and I would provide the option strategies to dovetail his work.
As any craftsman would, Steve brought along his tools, which
consisted of a chart book full of X's and O's on hundreds of stocks
and a Point and Figure technical analysis book written by A.W.
Cohen (this book is no longer in print). The basic principles of the
Point and Figure method were first published in 1947, the year I
was born, and the book was called Stock Market Timing. Each
week, Steve would fastidiously update these charts of X's and O's
and use them to make his stock selections. Over the first year,
Steve did very well. Stocks he selected to rise generally did.
Stocks he felt would decline generally did. His calls on the market
and sectors were also very good. The team was working well,
and best of all, we were self-contained. We were a technical
analysis and options strategy department rolled into one. We
weren't always right, but we were more right than wrong and,
most important, we had a plan of attack.
Just as things were looking good, a specialist firm on the New
York Stock Exchange offered Steve a job with the opportunity to
trade their excess capital. It was an offer Steve could not refuse,
and I supported his decision to go. I found myself back in the
same predicament that I had been in a year earlier. Rather than
try to find someone else who understood the Point and Figure
method of technical analysis that I had become accustomed to, I
decided it was time to learn it myself.
Steve explained the basics to me and recommended I read his
closely guarded copy of A.W. Cohen's book. That weekend I started
reading it, and after the first three pages, my life changed. All the
years of operating in a fog, searching for answers, and believing it
was all too complicated to learn, came to an end. What I found in
the first three pages made all the sense in the world to me. I knew
in that moment what I would do for the rest of my life. This was
the missing link that all brokers needed to effectively service their
clients. We now operate the only Stockbroker Institute in the
United States, and it is the culmination of my dream that night.
We have trained hundreds of stockbrokers in this method and
watched their confidence and client profits climb through the roof.
We have also held our first Individual Investor Institute in concert
with Virginia Commonwealth University, and the auditorium was
packed. Something right is going on here.
On Taking Risks in Life
There are many similarities between the principles in sports and
the psychology of the stock market. I am a world record holder in
powerlifting, and in my endeavors to improve my lifts, I learned a
lot from Judd Biasiotto's articles in Powerlifting magazine. I have
gotten to know Judd personally, and we see so many similarities
between our two businesses that we have written articles together.
In fact, we will soon publish a book together that explains
how some of the psychological aspects of sports competition can
be applied to investing.
When Judd was working with the Kansas City Royals baseball
team, his roommate, Branch B. Rickey III, met a guy who was
willing to let us buy into a condominium project being constructed
in Florida. The deal was that we could purchase up to 10
condominiums at a price of 10,000 each. At the time, 10,000 was
a pretty good chunk of money, but the deal was extraordinary. If
everything went as planned, there was a good chance we could
double or triple our money in no time. Still there was a risk--there
always is a risk. Because it was beachfront property, the
taxes were very high. Unlike Branch, I did not have the money to
invest long term. I would have to borrow the money at a fairly
high interest rate and then hope that I could turn the property
over in a short period. Otherwise, I would lose a lot of money. In
the end, I decided not to do the deal. Of course, you know the end
of the story already. The property is now worth anywhere from
$500,000 to $1 million.
Yes, I could have been living in the Bahamas relaxing on the
beach, but I failed to take the risk. There is one thing I'm certain
of--if you don't have the guts to put yourself on the line now and
then, your chances of success are limited. To reach the top,
athletes--or anyone else for that matter--have to know how to live
on the edge. They have to enjoy the elements of risk and a little
danger. I'm not talking about taking needless, senseless, incalculable
risks, like running with the bulls in Pamplona or attempting
a 500-pound dead-lift when your personal best is 300 hundred
pounds; such actions prove nothing except that you have the
brain of an infant. What I'm talking about is intelligent, calculated
risk-taking in which the risk in question has a legitimate
This really speaks to the business of investing. You have to
be a risk-taker to even survive in this business, much less flourish.
Every time you buy a stock, you are risking your hard-earned
money. If you are a broker, you are risking your clients'
hard-earned money. If you can't operate in a high-risk environment,
then the business of investing is not for you. I have met
many investors and brokers who just couldn't make a buy decision
for fear of losing their or their clients' money. It's good to
have a healthy dose of trepidation in this business of investing
money. That way you don't make stupid mistakes, but freezing
only causes you to miss great opportunities. There is a big difference
between having a healthy respect for risk and allowing
risk to paralyze your thought processes. Many investors and brokers
simply can't deal with market volatility. A fine line exists
between managing risk and being controlled by risk. The stock
market is not a place for the faint of heart. To reach the pinnacle
in the personal or professional investment field, you have to
learn to live on the edge, to enjoy the element of risk and
danger--at least to a reasonable degree.
Look back through time and you'll find that people who had
the courage to take a chance, who faced their fears head on, were
those who shaped history. The people who played it safe, who
were afraid to take a risk, well, have you ever heard of them? I
love what Theodore Roosevelt said about this very issue:
It is not the critic who counts, not the man who points
out how the strong man stumbles or where the doer of
deeds could have done them better. The credit belongs to
the man who is actually in the arena, whose face is marred
by dust and sweat and blood, who strives valiantly, who
errs and comes up short again and again because there is
no effort without error and shortcomings, who knows the
great devotion, who spends himself in a worthy cause,
who at the best knows in the end the high achievement of
triumph and who at worst, if he fails while daring greatly,
knows his place shall never be with those timid and cold
souls who know neither victory nor defeat.
Roosevelt's words remind me of this business of investing, and
how many critics are out there ready to pounce on your every
misstep although they never step into the ring, never actually put
their reputation or their money on the line. In the case of a professional,
these critics never lose one minute of sleep because
they are worried about other peoples' well-being.
Do you see yourself in the preceding quote? Those of you who
are reading this book are the people in the ring. You are here to
learn this method to better help you fight the battle. You realize
that nothing is perfect and at times you will err and err again; but
quit, you will never do. As time goes on, you will begin to intuitively
understand things in the market that used to baffle you.
Eventually, you will reach craftsman status. The critics will continue
criticizing because that is what they do best. Just turn the
television on to any financial station and you will come away
with gibberish. Once you nail down these principles of analysis,
you will have no need for business periodicals or financial TV.
I remember vividly my broker years. My face was marred and
bloodied many times but I was in the ring trying, striving for excellence.
I just didn't have a plan back then. What a difference
this information and way of thinking would have made if they
had been available to me when I was a broker. Mix this with my
enthusiasm and dedication to excellence and the combination is
unbeatable. Many of you have already done this, and it makes me
feel so good to see so many of you actually making a major difference
out there in your own and others financial well-being.
Theodore Roosevelt was right, the credit goes to you the investor
or broker who is actually in the arena, who at times comes
up short again and again but in the end experiences triumph. This
is why I wholeheartedly recommend you learn these methods and
manage your money yourself. Win or lose, be the one in the ring
where the action is. Make the decisions, take the calculated risk,
live. Don't find yourself at the mercy of others or at the end of
your career having ridden the bus and looked out the window,
watching others reach greatness. It's all here for the taking. You
just have to want it. Sports are full of great physical specimens,
but there is a real shortage of athletes who are willing to play
their game with reckless abandon, and athletes who are willing to
put themselves and their careers on the line. Those who do are
usually the ones at the top.
The truth in that last line inspires me. If you're not willing to
risk, you have no growth, no change, no freedom. And when that
happens, you are no longer involved in living; for all practical purposes,
you have no life. You're dead, but you just don't know it. So
risk, for goodness sake. Be a part of life. You have the power to be
or do anything you want. You can produce miracles if you have a
mind to. You have the magic, you just have to tap into it. Get in
touch with it, make things happen, live--journey to the stars,
push on to new galaxies. If you don't, you will never know your