Resistance on a Point and Figure chart explained
Resistance on a Point & Figure chart are horizontal levels that stand out. Across a level of resistance, supply exceeds demand. As a result, typically the price drops back. However, resistance is not impenetrable. When demand is strong, a resistance level will break, morphing into support.
How to identify resistance on a Point & Figure chart?
Significant resistance on a Point & Figure chart is identifiable from a distance. Columns of Xs and Os should span a couple of years at least. Two tests are needed at a minimum to qualify a key level of resistance. However, one test is satisfactory providing it was a major high point. For example, a record high or a psychological level, such as the NASDAQ Composite at 5,000.
Supply and Demand relationship
Demand exceeding supply causes a column of Xs to rise into resistance. Thus, when the price stalls at resistance, demand is met by supply. Forces of supply and demand are fairly balanced should the price consolidate across resistance. Supply exceeds demand when the price drops away from resistance.
Forces of supply and demand are explained further in the support tutorial.
Psychology of resistance revisits
Once price resistance across a level is established, the premise is that resistance will be served across the same level, in the future. Resistance levels are often said to have memory. Well, it is actually the market participants that have memory. An investor who bought previously from that level will want to breakeven, having endured a paper-loss since purchase. Therefore, the investor sells, as do others in the same predicament. Consequently, supply intensifies from the same level as past declines.
Volatility across resistance
The reversal from resistance on a Point and Figure chart is not always immediate or guaranteed.
A few weeks of choppy activity in and around resistance is typical. Bull Traps across these levels are frequent. Consequently, a trader needs to be prepared, to avoid being whipped out on a false market move. Therefore, Point and Figure resistance is best viewed as a horizontal band. Rather than a line spanning just one box in depth.
Of course, not every P&F resistance visit is followed by price weakness. Point and Figure resistance can be broken.
What causes a break of Point & Figure resistance?
Investor confidence alters the balance of supply and demand. An upside break through P&F resistance reflects increasing investor confidence.
An investor who has confidence in a stock, sector or index, hits the buy button. A group of confident investors, creates greater demand. As a result, supply dries up, causing the price to explode northwards, through P&F resistance.
Existing long holders are also reluctant to sell. They too are confident of higher prices ahead. As a result, the price breakout extends beyond resistance.
Reasons for investor confidence
Rising confidence at the stock level may include an earning's beat, merger and acquisition activity, or perhaps a new product.
Equity indexes experience rising confidence for a number of reasons. For instance, a Goldilocks employment report, GDP beat, Political changes or geopolitical resolutions.
P&F Resistance formation explained
Point & Figure resistance levels are typically formed in two ways.
- Across previous price peaks. A peak results from demand being overwhelmed by supply following a rising trend. Over time, a series of peaks across the same level highlights a clear P&F resistance band.
- Previous support becomes resistance. In a falling market, as support levels are penetrated and defeated, they become resistance to rally attempts. This process, support turning into resistance, takes a few weeks to cure.
Trading Price Resistance
An opportunity for profit taking arises in a bull market when major resistance is visited. If confidence in a failure from resistance is high, shorts may also be entered.
When to consider profit taking on an investment?
Entering a short position at P&F resistance?
Trading price resistance may also involve execution of short positions. Such trades work best when a Bull Trap, or our 3SR signal, occurs across resistance. Such patterns are usually followed by sharper and harsher sell-offs. Reason being - more long positions are trapped in losing positions and will need to get out. However, short positions are only truly reliable during a bear market, otherwise declines tend to be short-lived.
Resistance clusters enhance trading conviction
A confluence of levels enhance the chances of failure from Point and Figure resistance.
Trendline resistance may simultaneously slice through horizontal resistance, as the price visits. That further bolsters the region as resistance. Additionally, the presence of a significant moving average, further decreases a level's permeability. Collectively, creating a trifecta of Point & Figure resistance.
The 30-week moving average value was printed in Chartcraft's chart books of the 1970's and 80's to complement P&F analysis. The level of that average is recorded in the table of data beneath the charts on our Point & Figure charting tool for the same reason. Alternatively, the ubiquitous 200-day moving average may also be used.
Where to position a stop-loss when shorting resistance?
Tests of resistance on a Point & Figure chart are often volatile as bulls and bears battle for supremacy. Therefore, mental stop-losses are best used to avoid being whipsawed out by a brief upward price spike. A mental stop-loss could be positioned one box above the highest column of Xs formed with the test of resistance.
Point & Figure methodology filters out trading noise, plotting only the price action that matters. As a result, levels of resistance on a Point & Figure chart are readily identified. With resistance popping out of the chart, investors are better informed. Profit taking is more timely. Portfolio hedges, such as short positions, are better executed.
Point & Figure Chart Resistance Explained by Example
History often repeats
During 2017 the Vanguard Emerging Markets ETF rallied into the $50 level. The rise encountered Point & Figure resistance, with direction turning south via a 3 box reversal in February 2018. A prior test of that level, during 2011, triggered a 30% price cut. History is presumed to repeat should trading appear jittery at known resistance on a Point & Figure chart.