Issue 49 Wednesday, July 10, 2013 Viewing Relative Strength with Point and Figure Charting Frederic Palmliden, CMT Senior Quantitative Analyst [email protected] Features Studies/Files Included: . Focus: Technical . Indicator . Markets: Equities, Futures, Forex . Workspace . Time Perspective: Short term, Intermediate term Summary Relative strength is a powerful technical analysis tool for observing the relative performance of two assets. It is a separate tool from the Relative Strength Index (RSI), which is a technical indicator for a single security. While relative strength is a useful technique, it can also be challenging to evaluate due to the associated whipsaws. Viewing relative strength using point and figure charting helps to alleviate the noise, and the combination of techniques offers clearer trend-change signals. This Analysis Concepts paper will showcase a custom indicator to generate relative strength in a point and figure chart format. The concept offers much flexibility and can be used across asset classes. The analysis in this paper utilizes the TradeStation feature known as “Charting 3rd Party Data in TradeStation.” For more information, search “3rd Party Data” in the TradeStation Platform Help. Figure 1: iShares DJ U.S. Financial Sector Index (IYF) Relative Strength against the S&P Dep. Receipts (SPY) Using Point and Figure Charting Viewing Relative Strength with Point and Figure Charting Page 1 of 9 Background Relative strength analysis is a simple but effective technical analysis tool calculated by dividing the price of one financial instrument by another. The resulting value is a ratio of two market prices. If the ratio is rising, then the symbol in the numerator is stronger than that of the denominator. When the ratio is declining, the symbol in the denominator is stronger. As a simple example, if the resulting plot of the price of Microsoft (MSFT) divided by the price of the S&P Dep. Receipts (SPY) is trending up, then MSFT is outperforming SPY. This would not necessarily mean that MSFT is advancing in price, but rather that the stock is performing relatively better compared to the benchmark. The advantage of relative strength is to spot trend reversals – when one symbol starts to outperform or underperform another symbol. A common drawback of relative strength is the associated noise that is often seen when plotting a ratio of two market prices (see figure 2 below). An indicator named Spread – Ratio is supplied in TradeStation to chart relative strength. Figure 2: S&P Del. Consumer Staples (XLP) Relative Strength against the S&P Dep. Receipts (SPY) Point and figure charting dates back to the late 1800s and was first known as the book method according to Charles Dow in a 1901 editorial in The Wall Street Journal. The main difference between point and figure and a typical price chart is that point and figure does not take time into consideration when graphing the price action. Only price changes are recorded with point and figure, versus plotting price over time in a typical bar chart. Therefore, during a quiet period in the market, there may not be much plotting at all, whereas an active period would generate much required plotting.1 A clear advantage of this method of charting is the greater ease in recognizing trend changes. A point and figure chart uses columns of Xs and Os, where Xs represent rising prices and Os declining prices Although TradeStation plots the Os as rectangles, they are still referred to as Os since that is how they were marked on graph paper many years ago. Each X or O represents a price increment (box size). (See figure 3 below.) A point and figure chart also uses a reversal criterion, which dictates how sensitive the chart is to reversals. By using a larger box size, fewer signals are provided. A typical choice for point and figure charting is to use a three-box reversal criterion. Viewing Relative Strength with Point and Figure Charting Page 2 of 9 Figure 3: S&P Sel. Energy Spdr (XLE) Using Point and Figure Charting TSLabs: RelativeStrength P&F Charting Indicator Description The purpose of the custom Analysis Technique is to generate the raw relative strength data to be displayed as a point and figure chart. That data will then be used as the primary data (i.e., Data1) in a new chart window and formatted as point and figure. The process of generating and converting the raw relative strength data into a point and figure chart involves three simple steps. Step 1: Set Up the Multi-data Chart The first step is to insert the needed two symbols into a TradeStation chart using a daily interval and to insert the custom indicator. In order to expedite the process, once the first needed symbol is in the chart, use the Insert - Symbol menu sequence from the Menu Bar to insert the second needed symbol. Then, use the Insert - Indicator menu sequence and select the custom indicator. Remember that the price of the first symbol will be used in the numerator for the relative strength ratio, while the second symbol will be used in the denominator. Therefore, the second symbol is the benchmark and the indicator plot shows the relative performance of the first symbol versus the benchmark. The indicator plot in sub-graph two is the relative strength of the first symbol against the second (see figure 4 below). Therefore, at this point, the custom indicator looks identical to the supplied Spread – Ratio Analysis Technique. What makes the custom indicator unique will become clear in the next step. Viewing Relative Strength with Point and Figure Charting Page 3 of 9 Figure 4: Google (GOOG) and the Nasdaq 100 ($NDX.X) with the TSLabs: RelativeStrength P&F Charting Indicator Step 2: Save the Data in a File The second step will utilize the Print Log. If the log is not visible on the desktop beneath the chart, enable it by clicking on the View -- EasyLanguage® Print Log menu sequence. By default, the custom indicator will print the dates for the relative strength data. Copy and paste the data into a new Microsoft Excel worksheet, leaving the first row clear. Next, select this column of data, right-click and select Format Cells. In the Number tab, choose Date and select the MM/DD/YY format. Then, back in TradeStation, open the Format Indicator dialog and type False in the PrintDate input field and True in the PrintRS input field (see table 1 below). The print log will then reset and print the relative strength values. Copy and paste this data into the second column of the Excel document, leaving the top row clear. Next, type “Date” and “Close,” respectively, in the first two cells of the first row (see figure 5 below). Finally, save the file as a CSV (Comma Delimited) (*.csv) file and close the document. Make sure that you remember the location and the name of the file. Table 1: Custom Indicator Inputs Input Default Description PrintDate FALSE Switch (True/False) used to print the relative strength dates. PrintRS TRUE Switch (True/False) used to print the relative strength values. DataSeries1 Close of Data1 Price used in the numerator of the relative strength calculation. DataSeries2 Close of Data2 Price used in the denominator of the relative strength calculation. Note: The file may be updated later by copying and pasting new data into the CSV without creating a new file from scratch. Viewing Relative Strength with Point and Figure Charting Page 4 of 9 Figure 5: Google (GOOG) and Nasdaq 100 ($NDX.X) Relative Strength Data in Excel Saved as a CSV File Step 3: Chart the Data in Point and Figure Format The third and final step involves charting the relative strength data in TradeStation as a point and figure chart. Open a new TradeStation Chart Analysis window using a daily time interval. Then, right-click and select Format Symbol. In the Settings tab, click on the Lookup button, and select the 3rd Party tab. Within the tab, click Add, and then click on Browse to select the path to the saved CSV file. In the same window, type a three letter combination in the Prefix field (e.g., wsx). The same Prefix and path may be used in the future for other CSV files. Make sure that the ASCII Type is selected in the top portion of the window. Click Ok and select the CSV file from the list. Then click Ok and click Ok again in the Format Symbol dialog, prompting the formatting window shown in figure 6 below to appear. Make sure that the MM/DD/YY Date format is selected and click Next through the next few screens, then click Finish. Figure 6: Format Symbol Dialog for Setup of 3rd Party Data Viewing Relative Strength with Point and Figure Charting Page 5 of 9 The relative strength data is then displayed just as the price of a symbol (i.e., as Data1) in the TradeStation chart. To display the data in a point and figure format, right-click in the chart and select Format Symbol. Then, in the Settings tab, select Point and Figure. The point and figure box size and reversal criteria can be adjusted in the upper portion of the same dialog (see figure 7 below). Also, make sure to change the default Tick Interval to a Daily Interval. Figure 8 below shows the final result of the process described above. For this particular example, a box size of 0.01 and a reversal criterion of 3 were selected (i.e., 0.01 x 3). Note: Saving the workspace will make it easy to access the chart again.