Technical Analysis From A to Z Blog

Thursday, February 23, 2006

Technical Analysis - The Gann Studies


Predicting the future is impossible, right? If he were around today, W.D. Gann would beg to differ. His first prophecy is believed to have happened during World War I when he predicted the Nov 9, 1918, abdication of the Kaiser and the end of the war. Then in 1927, he wrote a book entitled "Tunnel through the Air", which many believe predicted the Japanese attack on Pearl Harbor, and the air war between the two countries.


His financial predictions were perhaps even more profound. In early 1929, he predicted that the markets would probably continue to rally on speculation and hit new highs… until early April. In his publication, The Supply and Demand Letter, he delivered daily financial forecasts focusing on both the stock and commodity markets. As this daily financial publication gained notoriety, Gann published several books - most notably "Truth", which was hailed by the Wall Street Journal as his best work. Finally, he began releasing the techniques that he used to make these forecasts: the Gann studies.

What Are the Gann Studies?
In 1908, Gann discovered what he called the "market time factor", which made him one of the pioneers of technical analysis. To test his new strategy, he opened one account with $300 and one with $150. It turned out to be wildly successful: Gann was able to make $25,000 profit with his $300 account in only three months; meanwhile, he made $12,000 profit with his $150 account in only 30 days! After his results were verified, he became famous on Wall Street as one of the best forecasters of all time.

Here's how his techniques work. Gann based predictions of price movements on three premises:

  • Price, time and range are the only three factors to consider.
  • The markets are cyclicalin nature.
  • The markets are geometric in design and in function.
Based on these three premises, Gann's strategies revolved around three general areas of prediction:
  • Price study– This uses support and resistance lines, pivot points and angles.
  • Time study – This looks at historically reoccurring dates, derived by natural and social means.
  • Pattern study – This looks at market swings using trendlines and reversal patterns.

Figures such as these are the building blocks of the Gann studies.

Constructing Gann Angles
Before we begin, it is important to realize that this form of analysis - like most forms of technical analysis - is not set in stone but constructed out of empirical methods. Without further ado, here is the process used to construct a Gann angle:

  1. Determine the time units - This is one of the empirical processes. One common way to determine a time unit is to study the stock's chart and take note of distances in which price movements occur. Then, simply put the angles to the test and determine their accuracy. Most people use intermediate-term (such as one to three-month) charts for this as opposed to long-term (multi-year) or short-term (one to seven-day) charts. This is because, in most cases, the intermediate-term charts produce the optimal amount of patterns.
  2. Determine the high or low from which to draw the Gann lines - This is the second empirical process, and the most common way to accomplish it is to use other forms of technical analysis--such as Fibonacci levels or pivot points. Gann himself, however, used what he called "vibrations" or "price swings." He determined these by analyzing charts using mathematical theories like Fibonacci.
  3. Determine which pattern to use - The two most common patterns are the 1x1 (left figure above), the 1x2 (right figure above), and the 2x1. These are simply variations in the slope of the line. For example, the 1x2 is half the slope of the 1x1. The numbers simply refer to the number of units.
  4. Draw the patterns - The direction would be either downward and to the right from a high point, or upward and to the right from a low point.
  5. Look for repeat patterns further down the chart – Remember this technique is based on the premise that markets are cyclical.
Again, this requires some fine-tuning with experience in order to perfect. Because of this, the results will vary from person to person. Some people, like Gann, will experience extraordinary success, while others - who don't use such refined techniques - will experience sub-par returns. However, if the system is followed and sufficient research is put into finding the optimal requirements, above-average returns should be attainable. But remember, technical analysis is an odds game -add more technical indicators to increase your chances of a successful trade.

Using Gann Angles
Gann angles are most commonly used as support and resistance lines. But many studies have support and resistance lines. What makes this one so important? Well, Gann angles let you add a new dimension to these important levels - they can be diagonal.






Here you can see how Gann angles can be used to form support and resistance levels. Diagonal trendlines are commonly used to determine times to add to existing long positions, to determine new lows and highs (by finding significant breaks of the trend line), and to help discern the overall trend.

Conclusion
Is it possible to predict the future? W.D. Gann probably thought so, and seemingly proved it with his wildly successful returns. The system is relatively simple to use, but difficult to master. After all, it was Gann's uncanny ability to fine-tune his techniques that led him to enormous profits - the average investor is not likely to obtain these kinds of returns. Like many technical tools, Gann angles are best used in conjunction with other tools to predict price movements and profit.

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Saturday, July 09, 2005

Trading Tactics - Advanced - Counter Trend Rally

Roughly one month ago, we began to hypothesize the likelihood of a counter trend rally. Since that time we have gotten exactly that. We had set some targets for the counter trend rally and it's worth looking at the charts once again and asking ourselves do those numbers still look realistic, so here we go.

DJIA - Target of 9100 or possibly 9800

When we were measuring declines and potential targets a month ago, we indicated that if we began our measurements with the May high, then our target would be 9100 however, if the decline was measured from the March high then 9800 might be achievable. This past week we achieved the first target of 9100 and, interestingly enough, that's where we pulled back from. Now the question is are we done, or is a greater advance still to come. When I look at the other indexes, I see more room to roam higher and thus, we have to assume that we should extend our expectations to the higher of the two targets once we have digested the recent gains. Right now, I would suggest 9600 to 9700 as the target rather than 9800 simply because of the resistance zones that show up on the graphs. Take a look.






Click to enlarge chart

Note that support is just above 8700. To continue the climb and reach our objectives, we need to see the 8400 level hold. Anything below that would invite more selling and an end to this counter trend rally. Looking at the percentages, the recent highs mark roughly a 17% rally since the July lows. If we were to reach the 9600 target, that would represent a total of 22% for the move. Here, as with the other indexes, we have to realize that if our targets are accurate for this move, then roughly 2/3rds or more of the move has been seen already.

S&P 500 - Target of 1053

The chart on the SPX is beginning to look more like 1000 is probably a realistic target now. Here's the current chart.






Click to enlarge chart

We achieved 960 on this latest move and now the pullback area looks to be around 900-910. If we are able to turn higher again from that area, that's about another 10% move. We have already witnessed a 20% move off the July lows and if we were to make the revised 1000 target, that would represent a 24% move altogether. So, as you can see, assuming our targets are correct, the bulk of our move has already been made although the last 10% is nothing to sneeze at assuming we can capture it also.

NASDAQ - Target of 1700

The NASDAQ has surprised a bit as we expected that we might get a little more oomph out of it than has occurred. We were looking at a target of 1700. Instead, now it appears that a target of 1540 might be better justified. I suspect that we could still be surprised here but that's a lot of ground to make up in a market that doesn't believe that growth in technology spending is in the cards. Without that belief, it's hard to see the NASDAQ sprinting ahead at a faster clip than the listed issues. Here's the current graph.






Click to enlarge chart

As you can see, 1700 looks like a real stretch from here with the other indexes closing in on their targets already. The NASDAQ, up until this point, has only achieved a 17% overall from the July lows to the highs of the past week. If the retrace back to support on the move that looks to have began on Friday, then the next leg up could cover 200 points, or another 14%. Given our SPX and DJIA targets, that is still realistic although aggressive.

Trading Strategies

When we first talked of the counter rally, we laid out some potential trading strategies. We first indicated that it was critical to recognize where you are at in the current trend and how much longer you expect it to last. In the above work, we have suggested that we have about a 1/3rd of the move left in front of us if our trending assumptions are correct. What this means to us, is that we have to either keep closer stops on our positions on the next directional move or simply play smaller as we are getting closer to what we think is the potential end of this current advance. It also implies that we could begin to consider taking the opposite position (shorting stocks) and considering that the beginning of a trend move down.

In order to talk intelligently about the market, here's a graph with projections of what we think the charts could look like in another month or two.

This next leg up, if it occurs, would be the final leg up on this counter trend rally. Take a look at the projection on the NASDAQ to understand what we are saying and then we can cover strategies again.






Click to enlarge chart

Strategies - Beginning of a Trend

In our early work on trading a trend, we talked about the beginning of a trend having obvious stop loss points. If you consider the graph above, if we were to purchase stocks in the area labeled A, then we would essentially be buying at the start of the next leg of the existing short term trend and the obvious stop loss areas would again present themselves.

Also note that selling into the subsequent rally moves from A to B, would essentially be the beginning of a trend as we are currently postulating that this may be the end of the counter trend rally and a continuation of the longer term down trend. As with any good setup, the stop out area is present on our charts and we could trade that move in the same way, i.e., as the beginning of a trend.

Please do not lose sight of the fact that we assuming that we are more than half way through the current trend (short term counter trend rally) and, because of that, we have to exert extra caution in our trading as we certainly wouldn't want good trades to turn into bad ones if the trend were indeed to shift on us.

Strategies - Nearing the Middle of the Trend

This past week we played out our middle of the trend trading by using tight trailing stops to stop out of some positions as well as front running some positions and simply taking them at their respective highs of the day when exiting them. Lastly, we also held a couple of issues and even shorted into the move. All of these options were options that we talked about previously and in practice we employed each of them. At this point, we are attempting to finish the middle of the range trading by repurchasing some of the sold shares for what we believe will be the next run.

Strategies - Nearing the End of the Trend

One thing that we failed to talk about in our previous discussions on trend trading is that when we reach the end of a trend trade, we are almost necessarily beginning another trend ... just in the opposite direction. It is for this reason that you can consider scaling out of your positions towards the end of a trend by building up an index or individual opposite trend trading hedges. As you have noticed over the past week on the trading opportunities pages, we have began to build a nice sized short candidate list for future trades.

Ending Thoughts

Trend trading is dependent upon your ability to sniff out and attach yourself to a trend. The current running thesis is that we are probably 1/2 to 2/3rds of the way through the ultimate high in the current counter trend trading rally. We have recently employed the middle of the trend trading strategies and will soon look to repurchase some of the sold off shares. Our desire is to establish new positions once support is reached and then attempt to ride them higher. We are not desirous of putting on too much inventory for this next move, but enough to profit by it if it occurs. As the trading rally progresses to it's next level, we would want to consider the end of the trend type trading. Practically that implies that we would want to book trend profits and potentially begin building new positions that are essentially the opposite direction of the current trend.

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Wednesday, June 01, 2005

Trading Tactics - Advanced - Time Trading

Sophisticated technical indicators evolve from simple data inputs of price and time. While most traders understand how price patterns reveal hidden opportunity, many fail to comprehend how time impacts both tactics and results. Lacking a skilled understanding of opportunity cost, they misinterpret signals and waste valuable resources. Or, trapped in common trend relativity errors, they prepare trades in one time frame but execute them in another.

Opportunity cost defines how the trader manipulates working capital. For example, this important concept reveals why cutting losses efficiently is so important for long term survival. By its nature, taking any stock position dictates that those funds will not be available for another trade. This becomes a critical issue on account drawdowns when individual trades can dictate success or failure for the aspirant.

All trends in the markets are time frame specific. For example, the existence of an uptrend in a daily chart says nothing about the trend in the monthly or intraday chart. This highlights the importance of correct time input in preparing technical indicators or reading chart patterns. When improperly time-tuned, technical analysis loses its effectiveness. Alternatively, resonant time readings will evoke startling accuracy with otherwise mediocre data input.

Time Summation of indicators falls into three general categories: .

- Moving averages of elements such as price or volume
- Relationships between the open, close, high and/or low of individual bars
- Repeating cycles of price or volume behavior

Time Period of indicators falls into three general categories:

- Short Term
- Intermediate Term
- Long Term

Individual units of time are best viewed as relative periods, as opposed to daily, weekly or monthly lengths. Since no two technicians trade in exactly the same time frame, patterns and indicators must serve a broad range of uses. Fortunately, technical analysis studies a fractal market. Valid predictions may be made with indicators developed from 5-min bars or monthly ones in exactly the same manner. But don't be fooled: prediction can only be made in the same time frame as the tools being used to study it.

Trend Relativity: Trends are dependent on the time frame in which you are viewing them. While IBM shows a promising reversal taking place on the intraday, the daily and weekly show a major correction in progress. Notice how the weekly reveals an excellent buy point at the top of the multiyear price channel, a support level completely missed on the daily chart.

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Sunday, May 08, 2005

Trading Tactics - Advanced - Time of Day: First Hour

Pay close attention to the first hour of each market day. The volatile trading hides important information about the daily trend.

Closing markets seek equilibrium in stock supply and demand. But overnight activities upset this delicate balance, forcing volatile shifts in morning prices. Specialists calculate this initial imbalance through their order book, sometimes triggering a gap open. NASDAQ market makers communicate before the open by displaying outside pricing until the most aggressive members win the inside positions. In both venues, changing spreads seek the moving targets of opening demand and momentum.

The opening surge may or may not ignite a subsequent trend. The first hour searches for a daily trend by forcing prices through a testing gauntlet. This process provides the road map for the floor to set subsequent pricing for their securities.

The 3rd Bar Reversal often presents the first challenge. This test refers to the 3rd bar or candle of the 5-min S&P Futures contract, measured from the opening of the equity markets. This time zone also corresponds with 9:40am to 9:45am, the end of the 15-min delay built into retail access to market quotes. Painting price for this retail crowd ensures some additional volume for the market makers. But since this group can be the last paper in the door, other market forces may take over and (possibly) trigger a reversal.

A second zone for opening trend reversal begins shortly after 10am. The strong expectation of this 35-min test becomes a self-fulfilling event. It also has tremendous value for short-term traders. Many day traders don't want to enter positions until early testing shows the trend they want to trade will remain intact. The 35-min test allows them to get into the market while volatility remains high.

Trends that survive this 35-min reversal test often continue throughout the day. This tendency elicits another unique event of the first hour. The last 15 minutes of this important period trigger capitulation by the losing side. Price movement tends to the same direction as the winning trend for the day and can be quite strong as day traders enter their first commitments.

The first hour's activity sets a theme that will likely repeat itself frequently during the trading day. Market participants reveal their strengths and weaknesses in this testing gauntlet. Volume then drops sharply, often constricting price movement and setting range resistance difficult to penetrate until one side gathers new momentum.

NYSE TICK

Order within the Chaos - Daily buying and selling behavior create pulses of market activity characterized by order and dimension. NYSE TICK routinely develops parallel channels that identify natural entry and exit zones. When these channels are broken, activity surges in the direction of the break. Also note how TICK channel behavior organizes time into distinct units with high and low extremes appearing at predictable points.

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Tuesday, April 19, 2005

Technical Analysis - More On Entry Points

Clear Air


Traders turn profits by anticipating price movement. Although this sounds simple, many market participants don't understand how to locate impending change. Stock prices move back and forth endlessly. But when do these common swings represent good trades and when are they just dangerous noise? One answer lies in the relationship between price and time.

The singular goal of trading can be defined as locating price expansion just before it happens and taking a position to capitalize on the event. When price moves a greater distance over a lesser period of time, individual chart bars and candlesticks expand in length. This range expansion signals those points of greatest opportunity for traders and investors.

Clear Air identifies horizontal chart levels where prior stock trends exhibited sharp price expansion in either direction. The stronger the CA event, the more likely that price will trigger volatility on the next pass. This tendency allows traders to locate outstanding trades with little more than quick visual scans of their favorite stock charts. CA prediction is simple: the more often those bars expand through the same levels, the more likely expansion will continue.

Congestion limits volatility. Range expansion represents the state of least congestion and greatest volatility. However, it cautions traders to manage risk closely as opportunity and danger stand side by side. Although price may have sharp momentum in one direction, defense trading must be exercised. Clear Air space can produce violent reversals.

Predicting natural swing points in pre-existing Clear Air utilizes only known support/resistance and fibonacci retracement levels. Since traders tap detailed price and volume from prior passages, those points can be used for cross-verification to reduce risk. High probability setups can be easily identified with natural entry and exit triggers.

Clear Air exists at new highs and lows as well as prior price breaks and trends. But locating safe positions in this Clear Air requires detailed fibonacci projections and may lead to conflicting outcomes. Only disciplined traders should play on this dangerous field. Major breakouts and breakdowns often print few congestion and swing points that traders can use to identify support/resistance. And positions must be taken without the benefit of information from prior passages through the same price levels.

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Friday, April 01, 2005

Most Talked About - Courtsey Stockhouse

Canadian Top 10
V.OIL
T.FCP
V.TYS
T.TMC
V.GHM
V.MMI
T.GAC
T.UTS
V.BZA
V.SPQ

US Top 5
ONCY
BIOHF
HMSL
MPVI
LVFHF

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Sunday, March 13, 2005

Most Talked About - Courtsey Stockhouse

Canadian Top 10
T.TAH
V.GHM
V.OIL
T.QRL
T.WJA
T.FCP
V.HAO
V.SPQ
V.TMG
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US Top 5
BWLRF
MPVI
ONCY
SCSIF

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