To trade forex profitably, we need to catch trends and stick with them until they complete a healthy part of their development. While there are many indicators today available to the typical trader towards the purpose of identifying and trading trend patterns, point and figure charts stand among those for the simplicity of the signals generated and lack of clutter in the display. The strengths of the P&F chart is its simplicity. Although it may appear complicated or difficult at first sight to an inexperienced trader, in fact its laconic depiction of the market action makes it an ideal choice for trend following strategies where one would like to disregard most of the retracements, and volatility in favor of following the main momentum of the market.
A P&F chart consists of boxes and X and Os. An X indicates an uptrend, the price was rising during this period. An O indicates a period of falling prices. But unlike other kinds of charts, P&F charts do not record all the price action in a period. There are two important criteria for including any day's price movement on a P&F chart: box size and reversal amount. Box size determines the minimum amount by which the price action must move above the last trading days's close in a column of Xs (that is, in an uptrend), or below the close of the previous day in a column of Os (in a downtrend). Reversal amount determines the minimum movement when the price contradicts an ongoing trend. It is the minimum amount by which we'll need to negate a column of X's and begin a column of Os if the price goes down, and vice versa if it goes up. In other words, as long as the reversal remain less than the reversal amount in an uptrend, we'll have a column of X's, and when the same is the case in a downtrend, we'll have a column of Os. In the stock market, box size is often 1, and the retracement amount is 3.
It sounds complicated, but it really is very simple. Traders will buy or sell at reversal points. For example, when, after a period of X's the chart shows an O, it's likely that a reversal has taken place and it is time to short the market. Conversely, you may choose to jump in a trend after it emerges and keep buying and selling for as long as the main trend remains intact. Since the P&F chart only includes significant price movements, the reversals and trends indicated by it are thought to be more reliable.
The P&F chart is not exactly popular among traders, and many forex trading brokers do not include it in their standard packages. However, this does not make this tool any less efficient than others. If you favor this kind of charting in stock trading, and want to use it in forex, there's no reason to discourage you from doing so. The same rules and principles are valid, and due to the simple and uncomplicated nature of the P&F, you can even use your own hand calculations for drawing it at all times.
In order to learn to trade forex you must have the appropriate knowledge. ForexTraders.com offers free information to help educate yourself on strategies, analysis, how to choose among the many forex trading brokers and we even offer a free course!
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