The three-point reversal method in point-and-figure charting is a technique used in stock market trading to identify potential trend reversals. This method focuses on patterns that form after a significant price movement. Here's a brief explanation of the three-point reversal method:
Initial Trend: The first step is to identify the prevailing trend. This can be an uptrend or a downtrend.
Reversal Signal: For an uptrend, a three-box reversal occurs when the price falls by a predetermined number of boxes (usually three) from the highest point. For a downtrend, a three-box reversal occurs when the price rises by the same predetermined number of boxes from the lowest point.
New Trend Confirmation: After the reversal signal, a new column of Xs or Os is drawn to confirm the reversal and indicate the beginning of a new trend.
As per AW Cohen, the profit percentage in trade can be increased by taking trade on pullbacks. The pullback trade example in AW Cohen's writing refers to triple top/bottom formation using the 3-point reversal method. Trading using a double top/bottom formation for pullback trading is not desirable.
The Rules for Pullback Trading
1. Triple or Multiple Top-Bottom Breakout: This rule suggests that a more significant pattern, such as a triple top or bottom, is preferable for a pullback trade. This may be seen as a stronger indication of a trend reversal compared to a double top or bottom.
2. Breakout of One to Three Boxes: The breakout from the pattern, when it occurs, should be relatively swift and occur within one to three boxes. This implies that the price should make a decisive move beyond the pattern, indicating potential strength in the new trend direction.
3. Pullback into the Pattern: After the initial breakout, the price should experience a pullback into the pattern. A pullback is a temporary reversal in the price movement, and in this case, it should be back into the area of the triple or multiple top-bottom breakout.
4. No Reverse Signal from the Pullback: During the pullback, there should not be any signals suggesting a reversal of the trend. This means that the pullback is seen as a temporary retracement rather than a complete reversal of the trend.
5. Price Turns Around and Breaks Previous Breakout Column: After the pullback, the price should reverse and break beyond the previous breakout column. This is the confirmation that the pullback was indeed a temporary retracement, and the trend is continuing in the direction of the initial breakout.
6. Counting method of point and figure chart may be used for setting potential target.
