In this series on Relative Strength, we have delved into the core concepts and underlying logic of relative strength analysis. We have explored how to interpret relative strength, analyze it effectively on charts, and utilize various tools to scan for stocks exhibiting strength or weakness.

In today’s newsletter, we will understand how relative strength is plotted on Point and Figure (P&F) charts, the various patterns of P&F charts for scanning stocks, score these patterns, and finally learn to use a tool to understand the relative strength based on these patterns and the scoring system. In the end we will understand how to choose the stocks to trade.

Relative strength and P&F charts

Point and Figure charts are noiseless charts. Meaning, they only plot important price action. In P&F charts, price movements are displayed in the form of columns. An upward price movement is represented by "X," while a downward price movement is denoted by "O." When the price rises without reversing, consecutive "X"s are stacked vertically to form a column of Xs. Similarly, a column of Os is formed when the price declines continuously.

P&F charts typically use a 3-box reversal setting. This means the chart switches from a column of Xs to Os or from Os to Xs only when the price reverses by a magnitude equivalent to three times the box size. This is referred to as a column reversal. For instance, if the box size is set at 1%, a column reversal will occur when the price moves in the opposite direction by 3% (3 × 1%). When such a reversal happens, the new column is plotted adjacent to the previous one.

Some of the common box size to use on P&F charts are:

1. 0.25% (Daily TF): Short term timeframe

2. 1% (Daily TF): Medium term timeframe

3. 2% (Daily TF): Intermediate timeframe

4. 3% (Daily TF): Long term timeframe

In the previous newsletter, we explored how the relative strength of a stock can be represented as a line chart, simplifying the process of analyzing relative strength. Similarly, the relative strength of an instrument can also be depicted on Point and Figure charts, where the distinct patterns of these charts can be utilized to assess the instrument's relative strength effectively.

P&F patterns for Relative strength scanning

P&F charts are a swing chart. At any given time, the P&F chart will have 5 types of patterns active: Double Top Buy, Double Bottom Sell, Bullish retracement, Bearish retracement, Consolidation.

1. Double Top Buy (DTB): This is a bullish swing breakout pattern It is formed when a column of Xs is followed by a column of Os, which is then succeeded by another column of Xs that exceeds the high of the previous column of Xs. This is a bullish pattern. The column of O is a simple retracement. This pattern shows active outperformance.

2. Double Bottom Sell (DBS): This is a bearish swing breakout pattern. It is formed when a column of Os is followed by a column of Xs, which is then followed by another column of Os that breaches the low of the previous column of Os. This is a bearish pattern. The column of X is a simple retracement. This pattern shows active underperformance.

3. Bullish retracement: This is a semi-bullish pattern. This pattern forms when a DTB is followed by a column of Os but hasn’t breached the previous column of Os low. This pattern shows outperformance but underperformance in short term.

4. Bearish retracement: This is a semi-bearish pattern. This pattern forms when a DBS is followed by a column of Xs but hasn’t breached the high of the previous column of Xs. This shows underperformance but outperformance in short term.

5. Consolidation: Consolidation is any pattern that hasn’t given a breakout on the bullish side or the bearish side. Simply put, if a chart is not showing any of the above 4 patterns, then it is a consolidation. This is a neutral pattern.

Below are the patterns.

Scoring these patterns

We can assign numbers to these patterns that represent their nature of bullishness (outperformance in this case). Below is the scores that can be assigned:

1. DTB: 2 points

2. DBS: -2 points

3. Bullish retracement: 1 point. Because they are semi-bullish

4. Bearish retracement: -1. Because they are semi-bearish

5. Consolidation: 0. Because they are neutral.

This scoring system can be applied to identify the active pattern on the Point and Figure Relative Strength chart across the previously mentioned timeframes. By summing the scores from each timeframe, we can draw a conclusion regarding the instrument's performance. The maximum score will be 8 and the minimum will be -8. This method is called as Performance score

Adding a new dimension

When RS is analyzed from the perspective of patterns, the information is quite incomplete. For example, a DTB with 10 boxes after the breakout in the breakout column gives us more information than a few boxes after breakout in the breakout column. The former shows more momentum than the latter.

To solve this issue, we can simply multiply the number of boxes in the most recent column with the box size of the respective charts. Column of X will result in a positive number and Column of O will result in a negative number.

For example, let’s say the P&F RS charts are showing the following data on various box sizes: 10 X on 0.25%, 6 X on 1%, 6 X on 2%, and 3 Os on 3%. This will result in a score of 2.5, 6, 12, and -9 respectively. The sum of this data will be 11.5. This method is called as Ranking score.

This method has 2 advantages: More weightage is placed on the higher box size, therefore focusing on longer trend, and the number of boxes in the recent column is taken into consideration. The scores based on patterns and based on the box sizes be made into a tool called RS matrix, which is created by Definedge securities on their RZone website.

Stock selection using P&F Fusion matrix

This tool can be used to analyze the stocks in an index or a group of stocks. Then, the stocks with the highest Ranking score can be used to create a basket of stocks and trade based on price chart patterns and setup. Below is an example of the tool.

If this newsletter has sparked your interest in trading and technical analysis, be sure to check out TNT One. This exclusive membership grants access to a vast library of technical analysis resources that can be studied at your own pace. One of the key benefits of this membership is the weekly live session led by Prof. Kaushik Akiwatkar, where he analyzes the market and demonstrates the practical application of the concepts taught.

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