Technical Analysis of the Financial Markets — John J. Murphy
Macro Overview & Strategic Value
Chapter 11 introduces a fundamentally different charting philosophy: point and figure (P&F), which records pure price movement while deliberately discarding the time axis that defines every bar chart. Murphy’s core thesis is that removing time from the plot yields sharper, more objective, and mechanically precise buy/sell signals — a column of X’s or O’s only advances when price actually moves, so P&F charts compress quiet periods and expand active ones automatically.
This matters to a practitioner because P&F converts trading discipline into an almost mechanical rule set: box size and reversal size (1-box, 3-box, 5-box) are the only two configurable parameters, and once set, entry, exit, and stop-placement decisions follow directly from the chart’s structure rather than subjective pattern interpretation. This objectivity is explicitly framed as producing better trading discipline than bar-chart pattern reading, where two technicians can reasonably disagree.
Structurally, the chapter demonstrates that virtually every tool built in Chapters 4-6 (trendlines, support/resistance, reversal patterns, measuring techniques) has a P&F-native equivalent — but with unique innovations like the horizontal count (a P&F-exclusive measuring technique with no bar-chart parallel) and 45-degree trendline construction, showing that the underlying trend and pattern logic is transferable across charting formats even when the mechanics differ substantially.
Core Concepts & Mechanics
- Price-only, time-agnostic plotting — Only price changes of a defined box size get recorded; flat/quiet periods produce no new marks at all, meaning the chart’s horizontal axis reflects volatility/activity rather than calendar time.
- Box size and reversal size as the only tuning parameters — Box size sets minimum plottable increment; reversal size (in boxes) sets how large a countertrend move must be to start a new column; larger reversal sizes desensitize the chart for long-term investors, smaller sizes increase signal frequency for short-term traders.
- 1-box, 3-box, and 5-box reversal hierarchy — The 1-box (intraday) chart is the foundational, most granular method; 3-box charts (built from daily high/low only, no intraday data needed) suit intermediate-trend analysis; 5-box charts suit long-term trend study — and importantly, 3- and 5-box charts can be derived from 1-box data, but not the reverse.
- Precision of X/O breakout signals — A buy signal fires when a new X column exceeds the top of the prior X column; a sell signal fires when a new O column breaks below the prior O column low — producing sharper, less ambiguous breakout points than equivalent bar-chart trendline or pattern breaks.
- Horizontal count (P&F-exclusive measuring technique) — Counts the number of columns across a congestion base/top and projects that count (each column representing one reversal-box unit) from the pattern’s boundary; this has no bar-chart equivalent and provides a second, independent price-objective method alongside the standard vertical count.
- Complex vs. simple buy/sell signal hierarchy — Simple signals (a single column exceeding the prior one) require only 3 columns; complex signals (triple tops, ascending triple tops, spread triple tops, trendline-confirmed breakouts) require progressively more columns and carry progressively stronger conviction — giving traders an explicit signal-strength gradient rather than a binary buy/sell flag.
- 45-degree trendline construction (3-box charts) — Unlike bar-chart trendlines connecting actual highs/lows, 3-box P&F trendlines are drawn at a fixed 45-degree angle from the lowest O column (bullish support) or highest X column (bearish resistance), since severe data condensation makes conventional peak/trough trendlines impractical.
- Pole and trailing-stop protocol — An uninterrupted run of 10+ boxes with no reversal (“pole”) leaves a trader with no natural stop-adjustment point; the solution is placing a protective stop at the level where the next 3-box reversal would trigger, then re-entering on a subsequent reversal in the original trend direction if stopped out.
- Percentage-based logarithmic P&F charts — A modern variant (Ken Tower/UST Securities) sets box size as a volatility-calibrated percentage (e.g., 3.6% per box) rather than a fixed point value, automatically normalizing sensitivity across stocks with very different price levels and volatility profiles.
Technical Terminology & Reference Table
| Term | Operational Definition |
|---|---|
| Box size | Minimum price increment required to plot a new mark on a P&F chart |
| Reversal size | Number of boxes price must move against the current column to start a new column |
| X column / O column | Rising-price column / falling-price column on a P&F chart |
| Fulcrum | A well-defined P&F congestion area forming a base (accumulation) or top (distribution) |
| Catapult | A P&F breakout above/below a congestion area (fulcrum) completing the base/top |
| Horizontal count | Measuring technique projecting the width (column count) of a congestion area as a price target |
| Vertical count | Measuring technique tripling (on 3-box charts) the first column of a new trend and projecting it |
| Pole | An extended, uninterrupted run of X’s or O’s with no reversal column |
| Bullish support line / Bearish resistance line | 45-degree trendlines drawn from the lowest O column / highest X column on 3-box charts |
| Chartcraft method | A.W. Cohen’s simplified 3-box reversal technique using only daily high/low prices |
The Author’s Market Philosophy
Murphy frames P&F charting as offering superior signal precision and discipline specifically because it eliminates the discretionary ambiguity inherent in bar-chart trendline and pattern interpretation — the same trend, support/resistance, and reversal-pattern principles apply, but the mechanical box/reversal rules leave far less room for subjective disagreement about whether a breakout has actually occurred. His edge-generation model here is procedural rather than predictive: better outcomes come from applying a rigid, repeatable rule set (simple vs. complex signal hierarchy, trailing stop protocols, pole management) more consistently than competitors, not from superior forecasting ability. He also implicitly extends the “volume is embedded in price action” argument from earlier chapters — P&F charts intentionally discard volume as a separate data series, yet Murphy argues heavier trading activity still surfaces indirectly through denser plotting in the price-only record.
Systemic & Portfolio Integration
The horizontal and vertical counting techniques extend the height-based measuring/expectancy framework from Chapters 5-6 into an alternative charting format, giving systematic traders a second, independent method for setting reward-to-risk price objectives. The explicit trailing-stop and pole-management protocol is a direct, rules-based risk-management technique — translating the book’s general “protect profits, cut losses” philosophy into concrete P&F stop-placement mechanics usable in an automated or semi-automated trading system.
Important Formulas, Data, or Initial Examples
- Horizontal count formula (3-box chart): (number of columns across the base) × (box value × reversal size) = target distance, added to/subtracted from the base/top boundary. Worked example: 10 columns across a base,
- Vertical count formula (3-box chart): value of the first new-trend column × 3, added to/subtracted from that column’s starting point (effectively tripling the first leg).
- Swiss franc intraday example: a 5-point box, 1-box reversal chart constructed from 9 days of actual price data (4875 → 4880 → 4860 → 4865 → 4850, etc.), illustrating the requirement of at least two filled boxes per column.
- British Telecom example: horizontal target of 92 derived by tripling the base and adding to 50; vertical target of 102 derived by tripling the x-column and adding to 63.
- Percentage/log P&F example: America Online charted with a 3.6% box (7.2% for a 2-box reversal); Intel charted with a 3.2% box, yielding horizontal upside counts to 33 and 87.6.
- Reversal-size convention: 1-box for intraday/short-term, 3-box for intermediate trend (Chartcraft standard), 5-box for long-term trend study.
Active Recall Evaluation
- Why can a 3-box or 5-box reversal chart be constructed from 1-box data, but not the reverse — what does this imply about the information each format preserves or discards?
- Explain why P&F trendlines on 3-box reversal charts are drawn at a fixed 45-degree angle rather than connecting actual price highs/lows, as is done on bar charts.
- What is the specific problem the “pole” scenario creates for a trend-following trader, and how does the recommended stop-placement solution address it?
- How does the horizontal count technique differ conceptually from every measuring technique introduced in the bar-chart chapters, and why is it uniquely suited to point and figure charts?
- Why does Murphy argue that discarding volume as a separate data series on P&F charts doesn’t necessarily mean volume information is lost?
Answer Key (spoiler)
- The 1-box chart is built from granular intraday data, and larger reversal sizes (3-box, 5-box) are simply condensations of that same underlying data — collapsing multiple 1-box moves into fewer, larger-threshold columns; going the other direction is impossible because a 3-box or 5-box chart has already discarded the finer intraday price detail needed to reconstruct a more sensitive 1-box version, meaning each step up in reversal size is a one-way loss of granularity.
- Because the 3-box method’s severe condensation (using only daily highs/lows, not intraday detail) means genuine price peaks and troughs are compressed or obscured, making a conventional trendline connecting exact highs/lows impractical to draw consistently; the fixed 45-degree angle instead provides a standardized, repeatable reference line that still functions as a trend filter without requiring precise pivot points.
- A pole (an extended run of 10+ boxes with no reversal column) leaves no natural higher-low or lower-high point from which to raise/lower a trailing stop, so a trader riding a strong trend has no chart-based way to protect accumulated profits; placing a stop at the exact level where the next 3-box reversal would trigger creates an artificial but rules-based reference point, letting the trader lock in a stop despite the absence of any real corrective column to anchor it to.
- Every bar-chart measuring technique (head and shoulders, triangles, flags, rectangles) uses a vertical measurement — the height of the pattern projected from the breakout point; the horizontal count instead measures the width (number of columns) of a congestion area and projects that count as the price target, a technique that only works because P&F charts compress time into discrete price-based columns, giving “width” itself direct measuring significance in a way it doesn’t have on a time-based bar chart.
- Because intraday P&F charts record every qualifying price change as it happens, periods of heavier trading activity naturally produce more plotted columns and boxes (more price fluctuation to record), while quiet periods produce few or none; this means the density of plotting on the chart itself indirectly reflects the underlying trading intensity, even though no explicit volume figure is shown, preserving volume’s practical influence on the chart’s shape without a separate data series.