COMBINING P&F WITH BAR CHARTS -- DOW HITS NEW 2004 LOW -- TRANSPORTS LOOK OVERBOUGHT -- TECH SELLING PULLS NASDAQ LOWER
DOW BREAKS SUMMER LOW... Since I started writing about point and figure charts yesterday, I thought I'd use them again today to give a fresh look at the major market averages. I'll explain a little more about their construction. At the same time, I'll discuss their main benefits. Chart 1 is a traditional three-box reversal chart of the Dow. Each box is worth 50 points (you can vary the box size). The p&f chart shows alternating x (up) columns and o (down) columns. To reverse from one column into the other, the price must move at least three box sizes in the other direction. Buy signals are given when a column of x's exceeds a previous column of x's. A sell signal occurs when a column of o's falls beneath a previous column of o's. The red numbers and letters identify the start of a new month. Numbers 1 - 9 identify January (1) to September (9). The letters A - C identify October (A) to December (C). The real benefit of p&f charting is the clear identification of buy and sell signals. There's no ambiguity. The last Dow signal was a sell, which occurred earlier this month when the o line fell to 9950 and undercut the previous o column at 10000. The chart also shows the Dow testing its summer lows. A drop to 9750 would undercut the two previous zero columns and would be a more bearish signal.
Chart 1
Chart 2
A MORE SENSITIVE LOOK AT THE DOW... You can make a p&f chart more sensitive by making the box size smaller. In Chart 2, I reduced the Dow box size from 50 to 25 points. Notice the greater number of signals. This more sensitive p&f version shows four consecutive Dow sell signals given since the start of October with the first (and most important) one occurring at 10050. The red zeros represent today's downside action. In order to give a short-term buy signal, the Dow would have move up to 9925 to exceed its previous x column. For comparison purposes, Chart 3 is the Dow daily bar chart. It shows the same trend, but without the precise signals offered by the p&f chart. The bar chart shows the Dow breaking its August low. The p&f chart doesn't show volume and other technical indicators. Which is why it's good idea to use both types of charts together.
Chart 3
P&F STOPLOSS POINTS... Point and figure signals can be used to initiate new positions. Or they can be used to liquidate old ones. I've often been asked how one knows when to sell a position -- whether it's a winner or loser. P&F charts offer one solution. Let's use the Nasdaq 100 Shares (QQQ) as an example. Chart 4 plots a traditional three-box reversal chart of the QQQ with each box worth .25 cents. A buy signal was given at 34.75 during September when a column of x's exceeded the previous column of x's. Today's selling has produced a downside four box reversal which is in itself a caution signal. A trader worried about protecting profits could place a stoploss order under the last columns of o's at 35.75. Since each box is worth .25 cents, a drop to 35.50 would give a sell (or liquidating) signal in the QQQ. A second sell signal would occur at 35. Chart 5 shows a daily bar chart of the QQQ. The two red arrows to the right show where the p&f signals would occur. All it really amounts to is doing some selling if support levels are broken. You can do that with a bar chart. But the signals are cleaner on a p&f chart. Use both together and get the benefits of each.
Chart 4
Chart 5
MICROSOFT WEIGHS ON TECHS... A number of technology stocks came under heavy selling today, which explains the relatively poor Nasdaq performance. Because of its size, Microsoft caused the most damage. On Wednesday, the software bellwether moved up to a new three-month high. The downside action on Friday, however, caused short-term chart damage. Not only was initial support at 27.75 broken, but downside volume picked up noticeably on Thursday and Friday. That put the technology sector on the defensive. Since that's where recent leadership has been focused, tech selling produced a bad market day. Chart 7 shows a short-term sell signal being given on the Microsoft p&f chart.
Chart 6
Chart 7
DOW LOW PUTS TRANSPORTS IN JEOPARDY... Earlier today I wrote about the Dow Theory divergence between the rising transports and the falling industrials. I suggested that one of them was out of line and ended by saying that either the Dow Industrials had to rise or the transports might start to fall. So far, the Dow Industrials aren't showing any sign of rising. Today's 2004 low by the Dow may challenge the transportation strength. Although the transports are still in an uptrend, the 14-day RSI line is in overbought territory and showing a short-term negative divergence. Friday's selling of technology stocks also puts the Nasdaq uptrend in some jeopardy. Since that's where most recent strength has been concentrated, any more selling there could really put underlying support levels to the test. In the case of the Nasdaq Composite Index, that support is right around 1900 (see box). A second failed attempt to get over its 200-day average may also encourage more short-term profit-taking.
Chart 8
Chart 9
Chart 10
