- Less technology and technical involved
- Less whipsaws as in-built filter exists
- Recommended for medium to long-term investment analysis
- Short-term analysis difficult
- No time-frame can be theoretically associated with this method
- Leverage positions are difficult to manage without deep pocket
In this section we will understand the philosophy under which it came into picture. But before this it's worth to thank those great people who gave birth to and nurtured such a wonderful system. A little about them.
The way I see it is a bit different than what most of the vanilla literature talk about it. It's a chart of pure price movement in two directions - either UP or DOWN. There is nothing else in it. Unlike other charts - line, bar, candle it does not change the directions immediately. Market to me is just like a School class room without a teacher. It's in utter chaos, you can't hear anybody nobody can hear you and it goes on but there is so much noise. The noise often comes out of class room walls but students almost never. But when the teacher comes in, almost everything is in order! The teacher is the fundamental and the class are us the market players.
This PnF method, therefore, tries to elevate the market from a School class room to a College class room. Where it incorporates a discipline and puts a tolerance limit beyond which only the participants will react. It forces us to be disciplined and not get swayed in absence of fundamental clarity. So how does it do all these philosophical talk?
The chart is constructed with four components:
- Graph sheet
- Two symbols - X (for UP) & O (for DOWN)
- Daily data with Open, High, Low & Close (High & Low are must)
- A buffer figure - Block size (Chart Sensitivity) * Reversal (Noise Filter)
- If current symbol is X -->
- Check New High > Last High + Block Size --> Plot one more X on top of last X else
- Check New Low < Last High - Buffer --> Plot one O at new block position
So, we see Open and Close prices are of no use except for some overlay on the chart itself.
Buffer figure: Block size * Reversal
Let's take an example here.
The moment a PnF chart is flashed, we need to see one thing first - Construct, i.e. Block Size = 1, Reversal = Can not be ascertained from this chart (assume 3)
Now coming back to the example. This chart shows that the down trend is on. Current price is within 11 to 13 (assuming 3 point reversal).
Say, next day the H-L is 14 - 10. So what do we do next? Though there was test of high but the rule of the chart will ignore this as a noise and go ahead and put one "O" at 10! Now practically, if somebody observes the day movement and if the movement has been from 'High to Low', the chart's point of view is valid as the upside movement can be considered as 'noise'. However if it happened from 'Low to High', then this is not valid. But if up trend continues, next day the chart will anyway change column from "O" to "X".
So block size and reversal are two very important concept in this. Trend increases the price by incremental block and reversal happens beyond certain level of price point and not at every fluctuation.
In the next part of the we will straightway enter the analysis part and shall try to spend maximum time in analyzing several real-life charts.