The following educational information about the point & figure method is from Dorsey Wright & Associates.

The Point & Figure methodology has been around for over 100 years. One of the first proponents of the methodology was Charles Dow, first editor of the Wall Street Journal. We know that Charles Dow was a fundamentalist at heart, yet he appreciated understanding the supply and demand relationship in any stock. The Point & Figure methodology is a logical, organized way of recording the supply and demand relationship in any stock. We all understand the basics supply and demand. It is Economics 101. We know why tomatoes in the winter don't taste very good, don't have a very long shelf life, and are expensive. The same forces that move prices in the supermarket move the stock market. When it's all said and done, if there are more buyers than sellers willing to sell, the price will move higher. If there are more sellers than buyers willing to buy, the price will move lower. If buying and selling are equal the price will remain the same. By charting this price action, we can ascertain who is winning the battle between supply and demand, and evaluate changes in market psychology.

A Road Map for Investing

If you were going to take a trip from San Diego, CA to Denver, CO in the car, what would be the first thing you do? The first thing you would do is to find a map or consult your navigation system. You wouldn't just jump on any road and hope that it is the one that takes you to Denver. The probabilities of that happening are pretty slim. Most investors jump on any investment with no road map to guide them through their journey. The Point & Figure chart is a road map for the investment journey in any particular stock.

P&F Chart Tenets

The Point & Figure chart is simply a logical, sensible, organized way of recording supply and demand in any stock. It answers the question of WHEN to buy and sell.

X = Demand; rising column
O = Supply; declining column

Chart is plotted daily with the high and low, and each column must have at least 3 X's or 3 O's to create a new column as the columns alternate with the underlying price.

Time Reference: 1 = Jan, 2 = Feb, etc. A = Oct, B = Nov, C = Dec
Years are denoted at the bottom of the chart P&F Chart Tenets

Patterns

In the Point & Figure methodology there are 11 different, identifiable patterns in the chart. They are all just variations on 2 basic patterns. Those two patterns are the Double Top and Double Bottom.

The two most basic patterns:

Relative Strength vs Market

One of the most important tools in the Point & Figure method is relative strength. This unique tool measures the likelihood that a stock will outperform the base index, the S&P 500 Equal Weighted Index (SPXEWI). The calculation is quite simple:

RS Reading = (Stock Price / SPXEWI ) X 100.

This relative strength reading is then plotted on a Point & Figure chart. Every position has a traditional price chart and a relative strength chart where we look at the signal (long term RS performance) but also the column (short term RS performance).

Relative Strength vs Peers

In addition to measuring how a stock is likely to perform versus the market, we also measure each stock to a group of its peers. The goal of this relative strength chart is to pinpoint the "best in class." The calculation is straightforward:

Peer RS Reading = (Stock Price / DWA Sector Index) X 100

This relative strength reading is then plotted on a Point & Figure Chart. This chart is read similarly to the market relative strength chart. The signal, double top or double bottom, indicates likely longer-term performance while the column is an indication of near term performance versus others in the sector.

Bullish Percent Concept

Think about your favorite football team for a minute. If they played offense 100% of the time, they would be marginal at best. The same holds true when investing. There is a time to have the offensive team on the field, and a time to have the defensive team on the field. The problem that most investors have is they don't know what team should be on the field. When the offensive team is on the field, we focus on wealth accumulation strategies. When the defensive team is on the field, the focus is on wealth preservation. To determine which team is on the field, we use Bullish Percent indicators.

Bullish Percent:

The concept of the Bullish Percent was born from Ernest Staby in the 1940's who wanted an indicator that would force him to be bullish at the bottom and bearish at the top. It wasn't until 1955 that AW Cohen created the NYSE Bullish Percent. It is simply a measure of the percent of stocks on a Point & Figure buy signal. (Recall from our previous discussion that a buy signal is defined as a column of X's exceeding a previous column of X's, while a sell signal is defined as a column of O's exceeding a previous column of O's.) If there are 1000 stocks on the exchange and 500 of those are on a Point & Figure buy signal, the reading would be 50%. The bullish percent reading is plotted daily on a grid that goes from 0% to 100%.

Tenets of a Bullish Percent Chart:

X's represent buy signals being given in the underlying members of the universe and the chart is rising. Demand is in control of the market and the Offensive team is on the field (wealth accumulation mode).

O's represent sell signals being given and the chart is falling. Supply is in control of the market and the Defensive team is on the field (wealth preservation mode).

In addition to telling us what team is on the field, the Bullish Percent will tell us our field position. Levels near or above 70% can be considered higher risk as the availability of demand to continue to push the market higher is limited. Conversely, levels near or below the 30% can be considered lower risk as the availability of supply to continue to push the market lower is limited. Most of the time the truth lies somewhere in between.

There is an NYSE, OTC and Optionable (a universe of 2400 stocks from NYSE, ASE and OTC which have options listed on them) Bullish Percent.

Some of the more notable changes in the NYSE Bullish Percent of late included putting the defensive team on the field in April 1998, June 2001, June 2002 and the OTC Bullish Percent moved to defense in March 2000. The NYSE Bullish Percent also brought the offensive team on the field in September 1998, October 2001, October 2002, and March 2003 and late August 2007.

NYSE Bullish Percent Chart:

Sector Rotation

Numerous academic studies have shown that successful sector rotation is one of the most important determinates of portfolio success. Sectors rotate in and out of season just like the produce in the super market. Sometimes those trends last for years, other times for months. The key to successful investing is to capture the explosive, positive outliers on the bell curve of sector returns and avoid the negative outliers. There are two main tools DWA uses to guide a sector rotation strategy — Bullish Percents, an absolute measure; and Favored Status, a relative measure.

Sector Bullish Percents

The same bullish percent concept used to evaluate the broad markets is applied to sectors. Dorsey, Wright & Associates follows 40 different proprietary sectors in addition to the broad (and sub-) economic sectors. The percent of stocks on a Point & Figure buy signal for each sector is plotted on a grid from 0% to 100%. This is a measure of absolute price performance (participation) by the group.

Points to Remember:

70% and above is the Red Zone or higher risk area for new purchases in the sector.

30% and below is the Green Zone or lower risk area for new purchases in the sector.

X's = Sector is on Offense
O's = Sector is on Defense

Optimum point for new positions is when Sector BP is in X's and at or below 50%.

Sector Analysis

When determining which sectors to focus new positions on, those with a Favored status and good field position on their bullish percent charts (around 50% or lower in X's) will stack the odds in your favor. Favored sectors with strong positive attributes should make up the core of a portfolio.

Favored Sector Status

Favored sector Status relies heavily on the concept of relative strength. How is the sector likely to perform within the context of the overall market? Those sectors exhibiting positive relative strength characteristics have the highest probabilities of outperforming the market averages. The Favored Sector Status is a measure of the potential magnitude a sector has to move.

(Information is derived from Dorsey Wright & Associates Point & Figure research)