As we have mentioned when discussing Relative Strength, choosing the correct scale is an important part of Point & Figure Relative Strength analysis. Since Point & Figure charts do not include time on the x-axis, scale is what allows us to home in on the intermediate-term timeframe that tends to work best for Relative Strength. Too short of a lookback (or in this case, too small of a scale) can cause you to react to insignificant market noise, and too long of a lookback (or in this case, too large of a scale) can leave you exposed to substantial long-term mean reversion.
By default, the scale used for most premade Matrices is 3.25%. While this should work for most universes, there may be situations where another scale is more suitable or you may want to test the effectiveness of a different scale. Here are a few considerations that may help you determine what's best for your situation.
- The volatility of the securities in your universe- more volatile assets naturally have more noise in their charts, so they may require a larger scale to be able to filter out the noise and focus on the actual trend.
- The correlation of the securities in your universe- a universe of more similar securities may require a smaller scale since there is less separating the returns of one security and another
- The granularity of your universe- a universe of broad market ETFs will generally require a lower scale than a universe of more targeted ETFs or individual stocks
If your scale is too large, you will notice the Matrix includes many white boxes, which means there is not enough movement in the chart to be able to confidently say which security is exhibiting Relative Strength vs. the other.
- Matrix box sizes.pdf200 KB