VOLUME ONE – EDITION ONE
TRADIN G WITH THE TIME FACTOR THE BEST OF TH E TRADING TECHNIQU ES B Y W . D . G A N N – E X P L A I N E D , S I M P LY LY .
BY FRANK BARILLARO
DEDICATED TO THE MEMORY OF CARMELO BARILLARO Who always taught that in life it is much better to give, than to receive.
CI MA NCA LA TUOA PRESENZA, MA TU R IMA NI SEMPRE PRESENTE NEI N O S T R I P E N S I E R I E N E I N O S T R I C U O R I .
THE BEGINNING
It is possible to do what many will tell you is the impossible.
PREFACE
It is possible to do what many will tell you is the impossible. I am convinced there is a calculable geometric symmetry present in all financial markets. The secret is knowing how to find it. Once you know how to find it, you can apply it to predict the exact time and date of future market tops and bottoms, sometimes years in advance. I am certain of this geometry because I have I seen it. I have also been able to predict it occurring in the markets time and time again. In 2001, I am on the record for outlining in writing that my timing calculations were indicating that ‘September 11, 2001 is a date to be wary of.’ I also nominated the date which proved to be the yearly low for the Australian stock market in 2001 to the exact day. All of this before the event. I saw the geometry that unfolded in the precious metals Gold market which coincided with the end of the 20 plus year bear campaign in gold prices. It enabled me to make a number of long term investment decisions, including a first purchase of gold bullion when it was trading just above US$300 an ounce. Interestingly, the same geometry which ended the 20 year bear market was also present to within a week of calling the current all-time top in gold prices. In this course, I will share with you how all that unfolded. I have calculated, and have shared with colleagues (including my stock broker), future dates to watch in the Australian stock market which have been accurate at predicting major turning points in the market, more than two years in advance. More recently in 2011, I wrote to friends and colleagues outlining that the US equities markets will continue on to higher prices in 2012 and 2013 – advancing the bull market in US equities that has since reached all-time record prices.
My friends and colleagues often ask me to explain how I can do it. However I have always felt that it would need a book to provide them with an adequate answer. So, after much convincing, I guess this is that book. This book draws upon the input and experience of my good friend and long term confidante, Frank “Bob” Nigro. Together, we will be sharing with you over 30 years of collective experience in the financial markets and thousands upon thousands of hours of study and research into the trading techniques which we have seen consistently working for us to predict future market tops and bottoms. We have seen which techniques work. We have also figured out which ones don’t. The course summarises that 30 years of experience into simple to follow descriptions and illustrations. It does much of the hard work for you so that you can better understand the financial markets. It filters out the best of the best – and allows you to apply these techniques to your own stock, commodity or currency market analysis. Importantly, I will show you how to apply these Trading Tools in a manner that is simple to calculate and easy to understand. A few of these techniques are what Bob and I consider to be the best of those used by many of the professional traders and hedge fund managers currently out there. The majority however have been adapted off the works of W.D. Gann – who was legendary for his contribution to trading by technical analysis. The Trading Tools I am about to share with you have proven the test of time. They worked over one hundred years ago and I am confident they will continue working for the next one hundred years. This course will change the way you look at financial markets. By the end of it, I am confident that you will have learnt the geometric secret that is present in all markets – and that you too can achieve what others will tell you is the impossible. Frank Barillaro
Before you begin, please read this really important stuff first...
Firstly, thank-you and congratulations for purchasing Trading with the Time Factor. I have absolutely no doubt that this trading course will change the way you look at financial markets. I also want to welcome you to the start of a journey together. My goal is that by the end of it, I will have helped you to make better decisions about your investments and trading. The lessons I am about to share with you will stay with you for a life time. To fully appreciate them, you may need to read this course more than once. In fact, I strongly encourage you to do so. This course has been separated into two parts. Volume One is about PRICE. In it, you will find the best lessons I could find to help you determine the likely prices of future market tops and bottoms. It is all about teaching you “where” to buy or sell. If you find Volume One of interest, then I assure you that Volume Two will absolutely blow your mind. Volume Two describes how to TIME a market and your investments by using techniques to forecast the exact date of major market tops and bottoms. It is all about “when” to buy or sell. Imagine knowing when the stock market or the price of gold is going to make its next major bottom. What could that do for your investment portfolio? If you think it is impossible, then I encourage you to keep reading. You will soon change your mind.
Before we begin, there are some important housekeeping matters which we need to cover off first. There is some fine print below that you should take the time to read and understand before you proceed. But just in case your time is short, let me summarise the key points for you below.
This course is not personal advice I am not a licensed financial adviser, nor do I know your individual circumstances. If you are looking for personal advice, please consult someone who is appropriately licensed to do so.
This course is not general advice This course is about educational material on how to analyse the markets only. It aims to teach you how to make your own investment decisions. That’s right, so that you can make your own decisions. This course teaches you the theory on how to fish. Unfortunately, I cannot catch the fish for you. But I can at least show you where to look. Trust me, by the end of it I am sure you will be able to do it.
The contents of this course are confidential Please respect that I have spent hours upon hours in researching, drafting, writing and publishing this trading course. Not to mention the thousands of dollars spent. If you spent countless hours researching what the winning lotto numbers for next week’s jackpot were going to be and you told me, how would you feel if I shared those with the rest of the world on the internet? Now, I’m not saying that reading this course is going to be like winning the lotto, but I hope you take my point. After all, if you are reading this, you have agreed to terms of confidentiality with me anyway. You wouldn’t go against your word now, would you?
Accuracy of contents
One view isn’t necessarily the right view
The contents in this course have been prepared in good faith and may be based on information obtained from sources believed to reliable but no independent verification has been made, nor is its accuracy or completeness guaranteed. Each of the charts contained in this book have been hand designed by my good friend Joe Caminiti. Whilst we have attempted to re-create every line, angle, axis and label as accurately as possible we are only human and humans can make mistakes.
If there are any views or opinions expressed in this course, these may be the views of the author or other parties. Whilst everyone is entitled to a view or an opinion, it doesn’t necessarily mean those views or opinions are right... Just ask my wife.
These however should not detract from the message we are sharing with you. To the extent permitted by law, ThirtyTen Investments Pty Ltd does not give any warranty of reliability, accuracy or completeness of the information contained in this document and does not accept any responsibility in any way (including negligence) for errors in, or omissions from, the information in this document. The author or ThirtyTen Investments Pty Ltd is under no obligation to update or correct the information in this course.
Future Returns This is not a course telling you to implement a particular investment strategy or to invest into a particular market. That is a decision for you to make. Please bear in mind that when you are investing. The value of any investment and the income derived from it can go down as well as up. Never invest more than you can afford to lose and keep in mind the ultimate risk is that you can lose whatever you’ve invested. Please seek independent financial advice regarding your particular situation. Investments in foreign companies or foreign markets involve risk and may not be suitable for all investors. Specifically, changes in the rates of exchange between currencies may cause a divergence between your nominal gain and your currency-converted gain, making it possible to lose money once your total return is adjusted for currency. Okay. Now that all of that is out of the way, let’s begin,
Imagine knowing when the stock market or the price of gold is going to make its next major bottom. What could that do for your investment portfolio?
Before we get started
For a long time now, I have been mesmerised by the workings on Wall Street and the tales of fame and fortune by some of the great market legends such as Jesse Livermore, JP Morgan and the story of how the Hunt brothers cornered the silver market, making and losing billions in the 1980’s. In order to get the record straight right from the start however, I am not a full-time trader. As reluctant as I am to admit it, I am an investment banker by profession (but please don’t hold that against me!). A couple of years after my banking career started, I was fortunate enough to be given the opportunity of a traineeship on the foreign exchange trading desk at a major Australian bank – and I am still very grateful to the person who gave me that opportunity to this day. For me, it was a dream job. Although brief, I learnt many things about professional traders and the different ways they approached the market. I had already been a student of the markets and Gann theory for a number of years beforehand, but the experience on the desk certainly added a new dimension to the way I looked at financial markets and the way professional traders approached them.
Unfortunately, the dream was short lived. My father, who was an inspiration to me for many things, sadly passed away unexpectedly on New Year’s Day in 2006.
I am happy to cop such criticism – particularly if that person has read some of my forecasts and has a track record of being able to consistently produce them in writing as accurately as I have.
It prompted me to give up the traineeship so I could move back home from interstate to be closer to my family who needed me more at the time.
Secondly, but more importantly, I hope to demonstrate to you in this book that you don’t have to be a full time trader to apply the techniques I am about to show you. By the end of this, it is my goal to have shown you how anyone can observe the symmetry which repeats itself in financial markets with only a modest level of analysis and by keeping it simple…
Eventually, I assumed a role working in structured finance – it allowed me to remove my law degree from being just a paper weight at home and actually put it to some use. The rigours and demands of a job in investment banking however don’t afford me the luxury of being able to actively trade the markets day in and day out (not to mention the restrictive compliance rules on trading that come with such a profession). And becoming a proud father of two young children recently now consumes most of my spare free time. Nonetheless, I have still found a way to keep an active interest in the markets… and to calculate an accurate forecast or two along the way. I thought it is important for me to outline this to you from the start for a couple of reasons. Firstly, I am sure that there will be a few critics out there dismissing the idea that a book can be written about trading and the techniques pioneered by some of the market’s greats by someone who doesn’t trade the markets full time.
In writing this book, I have to recognise the contribution by my mate Frank “Bob” Nigro who has been a key driver in identifying what is the best of the best of the trading techniques I am about to share with you. Bob does earn his living from trading the financial markets. He has lived and breathed the markets day after day for more than fifteen years, and has always been his own boss. He answers to no-one, except the market, and sometimes, as Bob often tells me, his lovely wife and young daughter. He provides a wealth of knowledge which has made its way into this course and a perspective from a full time trader, just in case you believe this course needed any.
How the mathematical and geometric relationships work in the market
One of the things which I agonised over when writing this book was how to choose which market (or markets) I was going to refer to as working examples of how market geometry works. I have seen these techniques I am about to share with you work in all types of markets – be it, stocks, stock indices, currencies or commodities. To demonstrate this, I was tempted to find an example of a particular technique working in each of those markets and to write each chapter based on that. In doing so, however, I felt that it may not present the full picture which I believe is required in order to produce a successful forecast. For that reason, I have chosen to present the examples in this book using the United States S&P 500 stock index as the primary basis. In my view, this index represents the global benchmark of equity indices, so it is a pretty reasonable place to start. Rather than go back too far in time and pick out the best examples over the last one hundred years, I have chosen to use the most recent price action available (as of January 2014) – as I think this is probably more relevant to most of you. By the end of it, I hope to have shown you how all of the Trading Tools presented are still relevant in the market today dominated by an age of computerised trading, just as they were one hundred years ago before computers existed.
Although I have chosen the S&P500 as the basis for this book, it is important to recognise that the forecasting techniques I am about to show you can be applied to all markets. For that reason, where appropriate, I will be using some additional examples from the gold and silver markets as well as some examples of the Australian equity market, as they are basically the markets where I first cut my teeth and began to apply my learnings and making forecasts. I will show you how to construct a road map for the next 12 to 24 months ahead so you may determine the likely position of the market. In addition, Bob has been kind enough to share the trade entry techniques that he has refined over the years in order to successfully trade off a forecast top or bottom and the tips that he uses to minimise losses and maximise profit. Calculating a successful market forecast is a bit like a jig saw puzzle that requires you to put all of the pieces (or techniques) I am about to show you together. This course tries to simplify the jigsaw into fewer pieces. I trust that you will find these examples as illuminating and useful as I do.
Each technique I am about to show you is an indicator which works in harmony with the others. The most successful forecasts therefore work when these techniques are all working together.
Discovering the geometry in markets
Bob and I began our journey studying the financial markets both as university students in the late 1990’s. Our study was heavily influenced by the work of W.D. Gann in the early days, but we soon came to realise that there were many other tricks which worked just as well, if not better, and more consistently in the markets. Having been Gann students for a number of years, the realisation that his techniques are not the be-all and end-all to trading helped simplify our thinking and improve our analysis greatly.
– This book therefore isn’t all about Gann. It is about the best of the techniques which we have found to consistently work out there – and a number of them are used in practice by the professional traders in the current day! I had been trying to convince Bob for a number of years to help me with writing a book on the subject. Consistently, he has been able to find a good reason not to do it. Bob prefers to have his privacy and to focus his time on trading, and I respect that. Likewise, he has been trying to convince me for years to give up the banking game and join him full time in the pursuit of the markets.
Whilst I have been very tempted at times, I have been enjoying the challenges and rigours of the banking world too much, particularly while I am still young and energetic. I know that the markets will always be there tomorrow and that once you have mastered the techniques I am about to show you, that they will stay with you for a lifetime. Both of us had therefore agreed to leave the book for another day. Becoming parents recently however certainly has changed our perspective. This book therefore has much to do with making sure we have a record of our experiences in writing for our children to follow should they one day choose to explore the markets like we have. The product of this book is exactly how Bob and I would attempt to teach our 30 years of collective experience to our own. I say that with the upmost sincerity. This book represents thousands of hours of our research in state and university libraries, hours upon hours of market analysis, and actual trading experiences along the way. What you are receiving are the Trading Tools which we feel represent succinctly, and simply, what is the best of the best for analysing the markets.
If you thought the price tag of this book was expensive, it might be worthwhile to point out that it has probably cost you a lot less than a trip to the dentist. My sincere hope is that in reading it, it is nowhere near as painful! And just in case I have left you wondering how Bob got his nickname, it is a pretty simple story really. Bob used to spend quite a considerable amount of time at our family home as we started out, trawling through all sorts of books and historical charts of stocks and commodities as we tried to figure out how this stuff all worked. He was like an adopted brother to me and my two younger siblings. Having the same first name as your best mate however can have its disadvantages. Eventually it became a bit confusing for my two younger brothers each time one of them tried to attract our attention – they would often yell out “Frank”, and naturally, both Bob and I would turn around. Eventually, they decided to call myself “Bill” and Bob, “Bob” so the two of us could distinguish one from the other. The name Bob stuck. Fortunately, Bill didn’t – so I have always been just Frank.
Who was W.D. Gann and why is he relevant?
William Delbert Gann is legendary when it comes to Wall Street and the impact he has had on trading the markets. Arguably, he has contributed more to the study of technical analysis than any other trader past or present.
Many have explained in different variations the premise for why Gann’s theories work. One simple explanation which I think resonates is that as human nature will never change, history is destined to repeat itself.
Gann developed the theory that there is a discernible relationship in all financial markets between time and price. He believed that the geometric representation of price through time would reveal important cyclical patterns within markets that had predictive values. In other words, future projections in the stock market can not only be made to calculate price, but also to forecast the dates of future market tops and bottoms.
As a result, future generations will repeat the behaviour (or cycles) of previous generations, thereby causing all financial markets to work in cycles which will repeat over and over.
Gann is reputed to have taken more than $50 million from the stock markets over his career in the first half of the 20th century – which is worth over a quarter of a billion in today’s money. In his published annual forecast for 1929 he figured that ‘a top must come no later than the end of August and that a “Black Friday” would come in September.’ He also nominated 3 September, 1929 as a key date. History will show that the high in the Dow Jones Industrials index which preceded the Great Depression was reached on 3 September 1929. What followed was the greatest ever fall in stock prices to this day. In my opinion, that makes his work relevant!
At the start of his book How to Trade Profits in Commodities, Gann outlined that:
‘Observations and comparison of past market movements, will reveal what [markets] are going to do in the future, because the future is but a repetition of the past… The average man’s memory is too short. He only remembers what he wants to remember or what suits his hopes or fears. He depends too much on others and does not think for himself. Therefore, he should keep a record, graph or picture of past market movements to remind him that what has happened in the past can and will happen in the future.’ Gann believed that price charts which revealed the past performance of stocks or commodities held the key in order to predict the future performance of a stock or commodity.
By looking at a historical chart of prices, one should be able to identify the past cycles which have occurred, and which will inevitably repeat in the future. Of course, over the years, I have learnt that there is a little bit more to it behind the theory of Gann than what I have simplified from the quotes above. For our current purposes however, it is important for you to recognise that in order to discover the predictable geometry that is present in all financial markets, you must accept that market cycles have, and will, repeat. This is the foundation for being able to successfully forecast future market tops and bottoms.
The Ticker and Investment Digest – Volume 5, number 2 (December 1909)
If you are still not convinced by the relevance of Gann and the trading methods he pioneered, the following excerpts might help. In December 1909, a publication called “The Ticker and Investment Digest” interviewed Gann after he provided them with a number of accurate predictions on commodity prices using the trading methods which he had developed.
The article started by stating:
Sometime ago the attention of this magazine was attracted by certain long pull Stock Market predictions which were being made by William D Gann. In a large number of cases Mr Gann gave us, in advance, the exact points at which certain stocks and commodities would sell, together with the prices close to the then prevailing figures which would not be touched…
The publication sent one of its staff to observe Gann real-time trading and the results he produced.
So much for what W D Gann has said and done as evidenced by himself & others. Now as to what demonstrations have taken place before our representative. During the month of October, 1909, in twenty-five market days, W D Gann made, in the presence of our representative, two hundred and eighty-six transactions in various stocks, on both the long and short side of the market. Two hundred and sixty-four of these transactions resulted in profits; twenty-two in losses. In other words, in a period which covered less than a month, Gann made 286 trades with an extraordinary win to loss ratio of over 92%. That trading resulted in a return of over 1000% of his original capital. And just in case you thought that was a typo, it was 1000%. In my view, this is a trading record that I have never seen repeated by anyone… ever! If somebody has, then they certainly aren’t telling anyone about it.
But what stood out to me the most from that article in 1909, and which continues to stand out to me each time I read it, is the following paragraph:
One of the most astonishing calculations made by Mr. Gann was during last summer [1909] when he predicted that September Wheat would sell at $1.20. This meant that it must touch that figure before the end of the month of September. At twelve o’clock, Chicago time, on September 30th (the last day) the option was selling below $1.08, and it looked as though his prediction would not be fulfilled. Mr. Gann said, ‘If it does not touch $1.20 by the close of the market it will prove that there is something wrong with my whole method of calculation. I do not care what the price is now, it must go there.’ It is common history that September Wheat surprised the whole country by selling at $1.20 and no higher in the very last hour of trading, closing at that figure. So there you have it. Not only do I believe Gann is relevant, he was at times, truly astonishing.
The philosophy behind price and time
Gann observed that price cannot exist outside of time. He was able to quantify that whilst the price of any stock, bond, commodity or currency stops trading as the market closes, time continues forward and is indifferent to price. Most of you would be familiar with how a stock chart plots the price of a stock or commodity displaying its historical price action as a function of time.
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Price is depicted on the vertical y-axis of a chart, whilst time is recorded on the horizontal x-axis. Gann identified that there is a total regularity to time. Each of the hours, minutes and seconds of a day can be scientifically measured with precision and measured against a predictable time line on a chart. At the time, this was a revolutionary concept.
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Intro .01
One thing which is important to realise is that Gann operated in an age where computer technology did not exist. Accordingly, he kept a meticulous collection of hand drawn charts. He did, for the most part, go to painstaking effort to ensure he recorded his data on charts which were created with equal intervals in both time (as measured on the horizontal axis) and price (as measured by the vertical axis). Gann employed the use of chart paper with eight squares to the inch, with every fourth line highlighted.
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This allowed him to create a chart that was scaled where one unit of price (for example, one cent or one point on a stock index) was exactly in proportion to one unit of time (for example, one day, week or month). Personally, I think the need to keep track of your charts on grid like paper is no longer required given there are so many effective trading software programs out there today to do it for you. If however, you do intend to maintain hand drawn charts like Gann did then I would highly recommend doing so by using the same 8 x 8 chart paper that Gann used, and keeping your charts in the same price to time relationship.
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This method will help you immensely in seeing the geometry unfold with your very own eyes, and will be of considerable assistance if you do go about attempting to re-create some of Gann’s charts or work through many of the examples he left behind in his writings, by hand.
Fibonacci
There is no doubt that WD Gann has heavily influenced my thinking and the way I approach my analysis of the markets. But it was the discovery of a broader, underlying geometry present in the markets which made me realise that my analysis had to extend far greater than his work alone. I was aware of the Fibonacci sequence and its application to the financial markets when I began my traineeship as a foreign exchange trader in a leading Australian bank. One of the up and coming traders on the floor, who I figured had about 5 to 10 years of experience, quizzed me whether I had heard of Fibonacci on my first day on the role – he was expecting me to have no idea who Fibonacci was, and to send me off on a research journey so that I would stay out of his way for a little while. Much to his surprise, I told him what I knew about the mathematician, so he sent me off to fetch him a coffee and a sandwich instead! To be perfectly honest, at the time, I was more surprised that he knew who Fibonacci was – and surprised even further when I learnt that he adopted the Fibonacci sequence in his trading. I quickly learned that Fibonacci was used by a number of the other seasoned traders on the floor.
The Fibonacci sequence was named after Leonard Fibonacci, the author of the book Liber Abaci written way back in 1202. Whilst Fibonacci is acknowledged for introducing the sequence to Western European mathematics, its origins are dated back much earlier into Indian mathematics. The Fibonacci sequence of numbers follows a distinctive pattern which can be found throughout a number of biological structures such as the branching in trees, the growth pattern of a flower and the arrangement of a pine cone, amongst others.
The sequence is depicted by a set of numbers as follows: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144… and so on. Each number in the sequence is simply the sum of the two preceding numbers, allowing the sequence to continue indefinitely. In the example above, I have deliberately left the sequence to end at 144 – it is a number you will become familiar with a little later. What is remarkable about the Fibonacci sequence, and why it is so relevant to the geometry of markets, is that the numerical sequence is such that each number is approximately 1.618 times greater than the number preceding it.
At this point in time, I think it is important for you to pause and reflect on that number 1.618, as you will see it (or a derivation of it) appear time and time again in the markets. The relevance of 1.618 to geometry is that it closely reflects the mathematical “Golden Ratio.” The Golden Ratio has fascinated Western mathematics for close to 2,500 years. Mathematicians from Ancient Greece first studied the Golden Ratio because of its frequent appearance in geometry. Since then, some of the greatest mathematical minds of all time, including Pythagoras, Leonardo of Pisa and the astronomer Johannes Kepler have spent hours analysing the Golden Ratio and its properties. Some have said that it has inspired thinkers of all disciplines like no other number in the history of mathematics.
The Fibonacci Retracement
In trading, I believe the Fibonacci sequence (in particular, Fibonacci Retracements) is used more frequently by technical traders than any other price forecasting tool in the industry. It is very rare for you to switch on the financial channel on TV and not hear one technical analyst or another discuss it. Perhaps it is the mere fact that nearly every technical analyst is aware of the Fibonacci Retracement is what makes it relevant. I will show you later on, just how powerful and predictive these retracements can be. A Fibonacci retracement is created by selecting two points on a chart, represented by a market top and bottom, and by dividing the vertical distance by the selected Fibonacci ratios. The percentages are then used to draw horizontal lines across the chart and identify possible support and resistance levels. The key Fibonacci level used the most is a retracement of 61.8%. Again, I point you back to the Golden Ratio number I referred to early. It can be found by dividing one number in the Fibonacci sequence by the number that follows it – for example, 55/8 9 = 0.6179. Whilst the mathematical result of the numbers in each of the sequences does not exactly equal 0.618, they are very closely approximate. The number to use in your analysis however is 61.8%.
I also like to use the ratio of 38.2% in my analysis. This is found by dividing one number in the Fibonacci series by the number that is found two places to its right – for example, 55/144 = 0.3819. Many traders will often use the ratio of 23.6%, which is found by dividing one number in the series by a number that is three places to its right – for example, 34/144 = 0.2361. In my analysis, I stick simply to 61.8% and 38.2%. For now, these are the only two numbers we need to worry about. The example in the next chart uses the market top identified as point A as the starting point and the following market low at point B as the end. (The price action in the chart actually reflects the movement of the Australian stock market from its all-time high in 2007 to the end of 2013). For the purposes of our illustration however, we will assume a nominal price for our starting and ending points. Each Fibonacci retracement level is calculated using the percentages between these two points). For example, if the top at point A occurred at a price of $11.00 and the low at point B at a price of $1.00, we have a range of $10.00 which we use to calculate the Fibonacci retracements.
The 61.8% point for example would be represented by the price $7.18 – which equals 61.8% x $10.00 + the low of $1.00. We will discuss Fibonacci in more detail a little later.
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Ralph Nelson Elliott
If you have spent any time studying technical analysis of the markets, you will probably notice the name R.N. Elliott come up – a lot. Elliot is credited with discovering his Elliott Wave Principle, which he used to describe market price movements occurring as a result of natural human behaviour.
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The underlying premise to Elliott theory is that markets represent a mass of people – the crowd – and their behaviour. Changes in the mass of psychology of the crowd will therefore cause fluctuations in markets based on the underlying pessimism or optimism of the crowd prevailing at the time.
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According to Elliott, this creates specific patterns which can be measured in the markets and will often repeat themselves due to the underlying basis that human nature over time never changes. At the heart of Elliott Wave Theory is that each major market movement (or dominant trend) will unfold in a five way sequence (represented below as 1 to 5), and each minor movement (or corrective trend) will unfold in a three way sequence (represented below as A to C).
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I acknowledge that this is just an over simplification of Elliott’s work, and I apologise if I have offended any of the Elliott Wave practitioners out there. However, what I have found, particularly with the increase of computerised trading over recent years, is attempting to identify a more detailed application of Elliott Wave sequence and applying it over the markets on the smaller moves (ie the moves that occur within the major long term trend) can produce confusing results. In the interest of keeping it simple, I stick to the basic five wave and three wave sequences above. In the next chapter you will see that this is one thing that both Elliott and Gann had in common.
Making it simple One of the pitfalls which I have faced when studying the various tools used in technical analysis is that there are so many indicators, it can make it difficult for the inexperienced to know which ones to use and when they should be used. Over the years, Bob and I have discovered that there were some techniques which work better and more consistently than others. This is particularly the case when using Gann. For Bob in particular, this has caused him to redefine his analysis and simplify the way he looks at markets. My own ability to forecast market tops and bottom also relies on a selected number of indicators which I use as primary tools.
These are the tools we will share with you in this course – keeping it simple.
The basis of this book is all about simplifying your analysis.
For me, too much information can make it all a little bit unworkable. With that in mind, the Trading Tools I am about to share with you are what I truly feel represent the absolute best.
SECTION ONE
The simple objective should be to trade the trend – not a perspective.
Identifying the trend
The first objective for anyone looking to analyse the market is to be able to identify the trend and make sure you are invested with it! This section is all about showing you how to review the historical price movements of your selected market and identify what the chart is telling you. It is my opinion that the greatest profits are made by making sure you are trading with the major trend and not against it. Not only can your profits be much greater, but trading with the trend is easier and requires much less work. One of the things you will need to control once you have mastered the ability to predict a market top is the lure of the fast gains that can be made by successfully being able to nail a high which precedes a crash. It is often said that ‘markets will go up by the stairs, but down by the elevator’ – in other words, bear markets bring fast profits. The problem is however, that markets in general (equity markets in particular) spend most of their time these days going up. If you are constantly being a perma-bear trying to call every market top, you will often see yourself sitting on the sidelines whilst the others are making the bull market gains.
A very good case in point is the bull market in Gold from the 2001 low to the September 2011 high. Whilst there were a number of significant corrections in between, the best money to be made was by holding a long position in gold over that period. Once you were able to identify that a bull market was underway, even a passive ‘buy and hold’ strategy would have rewarded you handsomely. On the other hand however, attempting to trade each of the corrections in the bull market and always trying to predict the top would have left you licking your wounds from being short, or feeling cold while you were out on the sidelines whilst the gains were being made. Repeat that experience if you were a perma-bear constantly calling for a correction in US equities to occur throughout 2012 and 2013. The safest money in that market (and the easiest) was made by the bulls – not by the bears. It was afterall, a bull market.
Chapter One – How to know you are trading with the trend
Markets will either operate in one of three stages of activity which can be described to categorise the direction of stock or commodity prices:
1900
1800
1. Bull market Where prices are going up, defined by higher tops and higher bottoms
1700
2. Bear market Where prices are going down, defined by lower tops and lower bottoms
3. Sideways market Where prices appear to be ‘range bound’ and are not consistently displaying the characteristics of either a bull or bear market
1600
1500
1400
Illustration of a Bull Market The following chart depicts the performance of the S&P500 market throughout the 2013 calendar year. Notice how the market was consistently making higher tops (in green) and higher lows (in red).
1300 O-12
N-12
The Bull Market
D-12
J-13
F-13
M-13
A-13
M-13
J-13
J-13
A-13
S-13
O-13
N-13
D-13
Illustrati on 1.01
In a bull market such as this, the safest money is made trading the long side of the market by trading with the trend. The ‘buy and hold’ theory works beautifully in these types of markets.
Illustration of a Bear Market The chart (right) depicts the performance of the S&P500 market throughout the bear market campaign which began off the high in October 2007 until it reached its final low in March 2009. Notice how the market was consistently making lower tops (in green) and lower lows (in red). Bear markets will often move faster in terms of price over a shorter period of time than a bull market, and can easily get ugly if you are on the wrong side of the trend.
The Bear Market
Illustration 1.02
Illustration of a sideways market The following chart depicts the performance of the precious metal market in Silver throughout 2011 and 2012. Notice how the market during that period was not distinctively making either higher tops or higher bottoms, but was rather trading within a range bound by the two horizontal blue lines. These types of trading conditions are a professional traders dream but can be a nightmare for the beginner who will often get caught buying from the professionals at the top of the range and selling back to them at the bottom. As an aside: notice how that it was not until late 2012 where the Silver market made its first lower top and lower bottom (as represented by the green and red markers) – this was your indication that the trend had turned down and that a bear market had commenced.
a
2011
The Sideways Market
2012
2013
Illustration 1.03
‘You will always m ake the most profit by following the main trend and playing the long swing…
The clear lesson to be gained from that piece of advice is that identifying what the trend is, is fundamental before one should even think about entering the market. You will produce much better results attempting to identify and trade a market bottom in the middle of a bull run than attempting to forecast each corrective top against it.
It is much better to make 3 or 4 trades each year and make large profits, than it is to try and make 100 to 200 trades a year and be wrong half the time, and finally end up with a net loss.
This is the view I shared with friends and colleagues in late 2011 when I became convinced that the bull market in equities was set to continue. Had I been looking for the short side of the trade all of the time, it would have proven itself to be quite costly. Those who were have missed out on some of the fastest gains in recent memory.
Let your rule be to –
GO WITH THE MAIN TREND, AND NEVER BUCK IT.
If you don’t know what the trend is, don’t get in the market.’
Source. W.D. Gann – How to Make Profits in Commodities (Pg 55)
Know what the trend is, and make sure you are on the right side of it!
Swing charts One of the simplest trend following methodologies used by Gann in his analysis was the construction of a swing chart. Gann used the swing chart not only as a trend indicator, but as the basis for a mechanical method of entering and exiting trades. In order to construct a swing chart, you will need to know the daily high and low prices in each time period you are using. For this reason, swing charts can be drawn using the traditional openhigh-low-close bar chart or from candlestick charts.
How to construct a swing chart The construction of a swing chart results in what Gann called a Trend Line Indicator. It can be created using any period of time – daily, weekly, monthly, yearly or even intra-day periods. When using a bar chart or candlestick chart, there are four classifications of ‘day’ types. Each is identified with respect to the previous day or period. 1. Up day = higher high and higher low 2. Down day = lower low and lower high 3. Outside day = higher high and lower low 4. Inside day = lower high and higher low
In each case above, you can substitute the word ‘day’ with your preferred period of time – for example, week, month, hour, or 15 minute period. In a bull market, the Swing Chart moves to the high of on an up day and keeps moving higher until a reversal day or down day is recorded. If the market has made three up days in a row, that will convert into one vertical line moving all the way up to the high of that third day. For the swing chart to move down, either a ‘down day’ or an ‘outside day’ would need to occur, causing the low of the previous bar (or ‘day’) in the upward move to be broken, therefore creating the swing down. The swing chart would then continue lower until a new ‘up day’ or an ‘outside day’ breaks new highs on the bar charts. To make your life a little easier, inside days are simply ignored for the purposes of constructing a swing chart. When an outside day occurs, my general rule of thumb is to follow what the intra-day price movements were when constructing your swing chart. For example, if we have had three consecutive up-days followed by an outside day that started the trading day lower, but then ended higher, I would swing the chart down to the low of that outside day, and then back up again – simply following the chronological movement of the market.
The swing chart provides you with a definable, mechanical method for identifying a trend and removes much of the ‘noise’ that is created when using just a daily bar or candlestick chart. When the swing chart is making higher tops and higher bottoms, the trend is up. Likewise, if the swings are making lower tops and lower bottoms, you should consider the trend down.
Multi-period or multi-point swing charts One useful adaption of the swing chart is to minimise the number of swing movements using time or price as a constraint. For example, rather than construct a swing chart using every bar (or day) as your time period to follow, you may increase the amount of time or price required to move your swing chart up or down. For example, Gann often worked with 3-day swing charts. A 3-day swing chart requires there to be three ‘up days’ to occur before the swing line is moved up. If only 2 days up occur, the swing does not move. You can follow this same approach by filtering the swings through price – ie a 100 point swing chart means you need a price move of 100 points or more before the swing chart line will move. You should vary the price used depending on your market.
The Swing Chart
Illustration 1.04
In my experience, I will most often use a one-day swing chart and a 2-day swing chart to confirm my forecasting. I have found that the 2-day swing chart in particular is useful to cut out some of the noise which can often result with the use of a daily swing chart alone. This is particularly so with the influence of computerised trading and many of the algorithm driven ‘black boxes’ out there which are programmed to trigger stops and therefore create false moves if using a one-day swing chart.
Chapter Two – Sections of the market
Earlier on we touched upon the Elliott Wave theory and the contribution it has made to technical analysis. One of the common things he shared with Gann was that they both identified that bull and bear markets often work to a set pattern, or structure which repeats in a predictable way.
On page 50 of his book How to Make Profit in Commodities, Gann discusses the various sections that a market will run in a bull or bear campaign.
Sections of Market Campaigns A Bull or Bear Campaign in wheat or other commodities runs out in 3 to 4 sections.
Bull Market 1st Section
Advance after final bottom, then a secondary reaction
2nd Section
Advance to higher levels, above the highs of t he first advance, then a react ion
3rd Section
Advance to new highs for the move. In many cases this means the end of the campaign. But you must watch for a definite i ndication before deciding that the third r un up means a change in the main trend
4th Section
Often four sections are run out and this 4th move or run-up is the most important to watch for the end of a Bull Campaign and a change in trend
Bear Market
A Bear Campaign runs opposite to a Bull Campaign
1st Section
There is a sharp, severe decline which changes the main trend, then a secondary rally on which Commodities are safer short sales. That marks the end of the 1st section.
2nd Section
There is a second decline to lower prices, followed by a moderate rally.
3rd Section
A third decline or move to still lower prices, which may be the end of the campaign.
4th Section
There is often a 4th move, which you must watch closely for bottom. In determining whether it is final bottom you use all of other [indicators], watching old tops and old bottoms and resistance levels for definite indication that the main trend is ready to change.
Minor Bear Campaigns of short duration, running one year or less often run out in two sections, especially if the 1st Section is from a sharp top. Therefore, always watch the action of the market after the 2nd decline to see if it is forming a bottom and gives indication of a change in trend. One of the subtle differences between the way Elliott and Gann described the movement of a bull or bear market was the way they referred to the movements within. Gann describe the market movements in “sections” whereas Elliott referred to them as “waves” which included the movements that were made against the trend. For example, in Elliott’s five wave sequence, waves 1, 3 and 5 are all with the trend, whereas 2 and 4 are against it. Gann by contrast when referring to his three “sections” was describing moves that were solely with the trend.
Identifying the trend – the simple way The ability to identify a section of the market is a simple task once you have seen the patterns unfold a number of times. Despite its simplicity, it is such a powerful tool to be aware of, as it helps you to identify what part of a run you are in within the context of a much larger and longer term trend. Identifying a section of the market is as easy as looking at a chart and identifying which top and bottom stands out. If you are analysing a bull market, look for a major low and the next proceeding major high and that will give you your section. Using a weekly or monthly chart will often help you in identifying these correctly for a major bull or bear market. It really is as simple as that – the trick is not to overcomplicate it! A key observation which I have witnessed from my analysis of past sections in major market campaigns, is that more often than not, there will be a noticeable fourth section that is much shorter than the previous third section in terms of both price and duration (or time). This to me is a red flag, warning me that the major market campaign is over and that a significant change of trend is about to take place.
It indicates that the momentum behind the current trend is beginning to fade and that the market is beginning to reposition itself – generally, the fourth section is where most of the professional money takes the opportunity to lock in profits and change their position. The following chart is a weekly chart of the S&P500 index between 2000 and 2010. It covers the last three completed market cycles at the time of writing (as the current bull market cycle from the March 2009 low is still in progress).
OCT 2007 TOP 1600 –
MAR 200 TOP 1
4
3
1 1500 –
2 1400 –
2
2
1300 –
3
1200 –
3
1
1100 –
1000 –
4
4
900 –
NEW BULL MARKET BEGINS
800 –
OCT 2002 LOW 700 –
MAR 2009 LOW 600 – 1999
2000
Sections of the market – S&P 500 index
2001
2002
2003
2004
2005
2006
2007
2008
2009
Illustration 2.01
The first of the major cycles ran from the top in March 2000 to the low in October 2002. You will have noticed that the market moved in 4 distinct sections down, with significant retracements up occurring in between. Importantly, each of these successive sections was characterised by a lower top and a lower bottom – confirming that the trend was in fact down. Noticeably, the fourth section down was significantly smaller both in terms of length (price) and width (time), indicating that the market had completed its bear campaign and that a long term bull market was about to commence. This was confirmed when the top of section 4 was taken out during the first phase of the new bull campaign starting in 2002. Following the October 2002 low you will again see how the market moved to 4 distinct sections during a bull campaign which ran exactly five years. You will notice that each of the four sections is characterised by higher tops and higher bottoms when compared to the last, indicating the trend is most definitely up. Some of you may point out that there was a significant correction within the first identified wave – I do not consider this to be a new section, as it did not break the previous high of the last section down which completed the preceding bear market.
Once again, the fourth section of this campaign was characterised by a period of smaller price movement up and shorter duration. The significance of the October 2007 top and the confluence of price signals at the top gave a very strong indication that the bull market was over and that a period of lower prices was to follow. Finally, following the October 2007 top, we commenced another bear market which lasted a period of approximately 73 weeks. Again, the final section of this bear campaign was characterised by a movement that was both shorter in terms of price and time. Final confirmation that the bear market was over was provided when the top of section 4 was broken to the upside after the March 2009 low had formed.
How to determine when the trend is changing Gann laid out his rules pretty simply on page 51 of How to Make Profits in Commodities under the section headed ‘How to Determine Change in the Main Trend by Space Movements’. In that section he outlines that:
‘When a decline in [price] exceeds the greatest decline of a previous reaction, it is an indication of a change in trend.’ He also identifies that we need to watch out for the time periods to determine when the main trend is changing. Again on page 51, he wrote:
‘When a campaign has run only 3 or 4 sections and the TIME period on a reaction exceeds the greatest time of a previous reaction consider that the main trend has changed.’ These are what Gann referred to as an overbalance in price and an overbalance in time, respectively.
Overbalancing of price There are two main things to watch out for when it comes to an overbalance in price. The first, is to measure each of the price moves with the trend. When these begin to get smaller, it is an early sign that the strength of the trend is weakening. If for example, you have been in a bull market that has been running up in sections of 100 points, then the first time you see a new section up that runs less than 100 points, this should provide you with the early warning that a change in trend is due. This is particularly so for campaigns that are in their third of fourth section in a cycle. The second thing to keep an eye on is the movements in price in each of the counter-moves within a campaign. For example, assuming we are in that same bull market that has been running up in sections of 100 points or more, and that the movements against the trend have been running at 50 points. The first time you see the market moves lower by more than 50 points, the market is telling you that price is overbalancing and that a potential change of trend is on.
Overbalancing of time The very same theory described to figure out the overbalancing of price can be applied to time. Say for example that each section of the bull market has been moving up in 90 day time frames. The first time you see a new section run up in a time period that is less than 90 days, it is the early warning indicator that the bull market cycle time is up and that a change in trend is due.
Likewise, the same works with respect to the movements in time for sections down. If in that bull market, the greatest period of time that a market has moved down has been 30 days, and the market makes a move lower that has continued for 45 days (as an example), time has now overbalanced and is warning you that the change in trend is in place. The best indicators are when you have both time and price overbalancing at the same time. This should be a major warning to you that the trend is changing.
Overbalancing of price and time – example S&P500 The overbalancing of price and time described by Gann earlier, is seen by measuring the countertrend moves within the sections of a major bull or bear campaign. A tool which I have found that has worked consistently is to keep a track of the price and time movements of the sections that are trading with the trend, as they will also provide you with a guide as to whether the trend is losing its momentum and is about to change. To provide an example of how easy these observations are to make in the market, I have depicted the bull market campaign in the S&P 500 index from the October 2002 low which we used in one of our examples earlier. To make the analysis simple, I have identified both the price and time movements (in calendar days) for each of the sections up, as well as the counter trend price movements (in price) for each of the sections down.
Important note:
Always watch out for changes in both price and time separately, but remember that the overbalancing of time is most important.
205 pts UP 1600 –
336 pts UP 1500 –
1400 –
266 pts UP
1300 –
56 days
1200 –
394 pts UP
397 days
1100 –
1000 –
633 days
900 –
800 –
700 –
511 days
103 pts
107 pts
186 pts
600 – Oct-01
Jun-02
Feb-03
Oct-03
Overbalancing of price and time – example S&P500
Jun-04
Feb-05
Oct-05
Jun-06
Feb-07
Oct-07
Jun-08
Feb-09
Illustration 2.02
Table 2.01 Overbalancing of time and price – example S&P 500
Section One
Time
Price
Oberservations
511 days – up
394 points – up
Nil.
103 points – down
Nil.
266 points – up
Time expanding. Current 633 day move is greater than the 511 day move before it.
107 points – down
Price reaction the same as first reaction.
336 points – up
Time decrease, but price expanding.
186 points – down
Price reaction significantly greater than previous reaction. Early warning indicator to watch for a change in trend.
205 points – up
Significant decrease in time and price range up. Indication that a change in trend is forming.
Counter-Trend Reaction
Section Two
633 days – up
Counter-Trend Reaction
Section Three
397 days – up
Counter-Trend Reaction
Section Four
56 days – up
The example above shows that by the time the third and fourth sections in the bull market had completed, the momentum behind the market was beginning to wane. In particular, the fourth section of the market saw both the movements in time and price being significantly smaller than the previous moves in the sections up. The counter-trend moves (ie the moves down) in price were also beginning to overbalance, indicating that bull market had completed its cycle and the change in trend was about to take place.
Chapter Three – The trend measuring techniques used by the professionals
The basic trend line is used as a starting point for identifying the trend by almost all conventional technical analysts. To construct a trend line, you simply need to connect two points (either a low to a low, or a high to a high) in a historical price chart with a straight line, and continue to extend that line out into the future.
UPTREND
Using the trend line
DOWNTREND
In the case of a bull market, trend lines are recorded by linking a low to a low, and as long as the market continues to trade above that line, the trend is considered up. The reverse is true in the case of a bear market.
Illustration 3.01
Using the trend line
Trend channels
Trend lines can be used in one of two primary ways.
Another of the most commonly used technical tools by professional traders and hedge fund managers is the use of the trend channel. To construct a trend channel, you need to begin with a basic trend line as your reference point. A parallel line is then drawn on the other side of the price bars connecting a significant top or bottom, so that the price action is within the channel.
1. Firstly, it is assumed that the market will continue in the direction of the trend until the trend line is broken. Once a trend line is broken, it is an indication that the trend has changed, and prices will continue heading in the broken direction. For example, if an upward sloping trend line is broken, it could be interpreted as a signal to sell - either to liquidate a long position or to instigate a fresh short position. 2. Secondly, trend lines are often used as places to present buying or selling opportunities. When market prices move back to the trend line and then ‘test and hold’ against the trend line, it is a signal to buy or sell off that point. In the case of a bull market, for example, this would occur if the price has moved down to the trend line, touched it and then rallied higher. A trend line is considered to be a ‘working’ trend line when it has been ‘tested and held’ by the market on multiple occasions. The greater the number of times a trend line has tested and held, the more significant it is when it is ultimately broken.
In the case of an up-trend channel, the high side of the channel is drawn across starting from a significant top, while in the case of a down trend channel the low side of the channel is drawn across the bottoms. The following chart is the weekly price action of the S&P 500 index across 2004 and 2007. Notice how the market traded within a downward trend channel for almost a year, before breaking out of the trend channel and trading higher. Once it had broken up, it then began trading within a new upward trend channel for almost a further two years, before a break out caused it to move to much higher prices.
Important note:
Trend lines (in particular working trend lines) always need to be watched as they are used by almost every technical analyst in the market.
1560 –
1460 –
BREAK-OUT 1360 –
RETEST L I N E N E L C HA N R E N D T L L L E PA RA
1260 –
BREAK-OUT 1160 –
1060 –
S
N
2004
M
M
Trend Channels – S&P 500 Example
J
S
N
2005
M
M
J
S
N
2006
M
M
J
S
N
2007
M
M
J
S
N
Illustration 3.02
Parallel trend channel lines I have observed quite regularly that secondary parallel lines can be drawn to create additional support and resistance trend lines within a working trend channel. In the same way that the regular trend channel is created by linking significant tops and bottoms, the secondary parallel lines can also be drawn in using other turns within the broader trend. In the previous example, I have created a secondary trend line (marked by the dotted line) within the upward channel by linking a significant bottom and extending an exact parallel line across. This secondary line provided support and resistance within the larger trend channel on a number of occasions.
Break-outs and re-tests You will find the occurrence of trend channels happening frequently in the markets, particularly in strongly trending markets where the price action will move within the trend channel for an extended period of time. You should also pay close attention for break-outs of the trend channels to occur. There are two types of breakouts to look for.
1. Break-out against the trend – which often signals a change of trend has occured (this can be seen in the first break out in the chart earlier) 2. Break-out with the trend – which occurs when prices move out of an existing trend channel, but in the same direction as the trend (this can be seen in the second break-out on the chart earlier) You need to be mindful that the market will often make false break-outs by trading slightly above or below the working trend lines. This behaviour occurs typically as the professional traders and ‘black box’ computer systems attempt to take out stops that a number of people place right above or below the working trend lines. A break out therefore should only be considered valid when there has been a strong move out of the trend channel and the market has made consecutive closes above or below the trend line. Lastly, it is also worth noting that once a trend line or trend channel is broken, the market will often trade strongly out of it, but then make a move back to ‘re-test’ the same trend line. In the earlier example, you can see clearly that when the S&P500 broke out of the upward trend channel, it made a subsequent retest which produced a terrific buying opportunity.
I am always on the look-out for these to occur when a working trend line has been broken and I have missed the initial break-out. It is one of the very few times when the market gives you another opportunity to get set with the new trend.
Moving averages This is probably the most widely used and most popular technical analysis indicator of all. Moving averages can vary depending on whether you are using a simple or exponential method of calculation. The simple moving average however is the most common. It is calculated by adding the closing price of the chosen market over a number of time periods, and then dividing this total by the number of time periods. For example, a 10 day moving average will add the last 10 days of closing prices and then divide the sum total by 10. As a general rule, the shorter the time period used in calculating the moving average, the greater the use it has in identifying the short term trend. In my view, the 10 and 20 day moving averages are the most commonly used by professional traders and hedge funds for short term trend analysis, whilst the 50 day, 100 day and 200 day moving averages are the most commonly used for longer term trend analysis.
The way in which the professionals use a moving average is to apply it as an indicator to guide them on the overall direction of the trend. If market prices keep trading above the moving average, the trend is generally viewed as up. Likewise, the trend is considered down if prices are trading below the key moving average.
Once there was a sustained breakdown of this longer term moving average, the trend turned lower for an extended period of time. Similar break out patterns occurred when the bear markets in 2002 and 2009 ended, as well as when the bull market in 2007 was over following the major high.
A secondary way in which the professionals commonly use a moving average is to use it as a buying or selling indicator. If a market has been trending above the moving average for a considerable amount of time, then many professional hedge fund traders will watch the market to see if it moves back to touch the moving average, before resuming the trend. The point of touch will represent the buying (or selling) opportunity.
Throughout 2012 and 2013, the market has been trading well above its 200 day moving average, supporting the view that the trend is still up. This moving average line therefore becomes important to watch to determine if prices can find support at the moving average, or whether they will undergo a sustained break-down of the 200 day trend line, which will be an indicator to watch out for a change in trend.
I have noticed that a 200 day simple moving average in particular is a pretty decent indicator to identify when longer term trends are beginning to break down. The next chart of the S&P 500 index shows how the 200 day moving average essentially held the bull market intact throughout 1995 to early 2000.
A number of trading systems out there will often employ the use of multiple moving averages which generate buy and sell signals when certain moving averages “cross” with one another. Personally, I have found the use of these types of systems to provide little to no assistance in my analysis, so I do not consider them when analysing the markets. In my analysis, I try and observe the 50, 100 and 200 day moving averages, and will use them primarily as indicators to help tell me what the rest of the crowd may be looking at.
1800 –
1600 –
BREAK = TREND DOWN
BREAK = TREND DOWN
1400 –
1200 –
1000 –
BREAK = TREND UP
800 –
BREAK = TREND UP
600 –
400 – 1995
1997
1999
200 Day Moving Image – S&P 500 Example
2001
2003
2005
2007
2009
2011
2013
Illustration 3.03
TRADING TOOL BOX ONE HOW TO TRADE WITH THE TREND
1. Trend Identification
2. Sections of the market
3. Overbalancing of price and time
• Identify the character istic that the
• Identify what section of the
• Keep a count of the price and time movements in each section to
market is trading in. Is it in a bull, bear or a sideways market? • Use your weekly swing chart to help you determine whether the market is making higher tops and higher bottoms (bull market) or lower tops and lower bottoms (bear market).
market cycle you are trading in. • Are you in the first, second, third or fourth section of a major bull or bear market?
determine if the market is beginning a change in trend. • Look out for overbalances in time and price which might suggest that the momentum behind the current trend is changing.
4. Trend l ines
• Are there any valid trend lines to
5. Moving averages
• Is the market trading above or
determine whether the market is in a definable, consistent trading
below the 50, 100 and 200 day moving averages? Me dium term
pattern?
trends will be referenced by the 50
• In a bull market, buying opportunities can be found when the market tests the bottom of a trend channel. (vice versa for a bear market) • Look to hedge your position or take profits at the top of a trend channel. The opposite is true in a bear market.
and 100 day moving averages and longer term trends by the 200 day. • Keep an eye out to see if the market moves back to touch a major moving average line for future price support or resistance - nearly all the professional traders do!
“Always trade with the trend – the objective should be to identify opportunities to trade in the same direction as each section of the market.”
SECTION TWO
This section of the course is all about demonstrating to you the geometric relationship that exists between past movements of price and how these can be used to forecast future moveme nts of price.
How to forecast price
Many traders and investors will probably know the feeling of what it is like to sell out of a stock too soon or buying into it too late. It can certainly be a frustrating experience selling a stock and seeing it continue to rise another fifteen or twenty percent. This section of the book is all about demonstrating to you the geometric relationship that exists between past movements of price and how these can be used to forecast future movements of price. Once you have mastered the ability to identify how past movements in price affect future movements, you will then be able to translate these into calculating future price support and resistance levels on any market – not only can this be useful in forecasting future tops and bottoms, more importantly, it will significantly improve your entry and exit points into your chosen stock or commodity.
Chapter Four – Price retracements
I think it is without doubt that one of the most commonly used technical analysis techniques is the price retracement. Nearly all on-line trading platforms contain a function allowing you to calculate pre-defined price resistance levels with the simple click of a button. I have found price retracements on defined levels to be one of the most reliable indicators available. Retracements in price on key levels occur time and time again, no matter what the time frame is that you are looking at. Gann covered this topic in quite some detail in chapter II of his book How to Make Profits in Commodities. There are probably two key sections in that book to turn your attention to. The first is on page 34 under the heading ‘Range of Fluctuations’ where Gann describes how to calculate price retracements using the previous range of price. The basic rule is to take a significant high or low of a price move and subtract the high from the low to get the range. You then divide the range using your price retracement levels to determine your support or resistance points. On page 34, Gann describes a number of percentages to use when determining price retracements. These are divisions of 12.5%, 25.0% and 33.3%.
According to Gann, you should therefore watch for support and resistance at the 12.5%, 25.0%, 33.3%, 37.5%, 50.0%, 62.5%, 66.6%, 75% and 87.5% levels. Personally, I think the use of so many levels in your analysis is overkill, particularly in fast moving markets such as stock indices or currencies. In Gann’s defence, he was writing about commodities (as the title of his book points out), and those divisions of price can be relevant in markets that trade at low prices. With that said, to simplify my analysis, I will filter many of these divisions out, and I therefore rarely ever use the 12.5% or 33.3% divisions in any of my analysis. The point I am trying to make, is that when you use every possible division of a range, you come up with too many price objectives and this will confuse your trading decisions. I have found that the use of the following price retracement points are all you need to know in order to produce a successful forecast and identify key buying and selling points:
38.2%
50.0%
61.8%
Strangely enough, these are often the default percentage levels used by most on-line trading platforms. Maybe it is the reason why they seem to work so often as everyone is looking out for them.
You will have noticed that two of my price retracement points 38.2% and 61.8% come from the Fibonacci sequence of numbers. The other level however, is what I consider to be the most consistent and powerful of them all – the 50.0% point. Gann describes this on page 36 of How to Make Profits in Commodities under the heading ‘The 50% or half-way point.’ In that section he says:
‘Always remember that the 50% reaction or half-way point of the range… is a point for support on the downside or for meeting selling and Resistance on the way up. This is the balancing point because it divides the range of fluctuation into two equal parts.’
Later on, he goes on to say:
‘You can make a fortune by following this one rule alone. A careful study and review of past movements in any Commodity will prove to you beyond doubt that this rule works and that you can make profits following it.’
I have found that the 50% rule has an application in markets no matter what the time frame being used. I use it predominantly on daily chart analysis to help me identify intermediate buying and selling points to provide an entry point that is with the trend. I know that Bob uses it heavily on his intra-day chart analysis, to help him with his initial trade entries. What I find truly astounding however is that a number of significant turning points in the market will often coincide with a 50% retracement. This is particularly so when a market turns on a fifty percent level between a yearly top and yearly bottom. As Gann outlined in his book – ‘The wider the range and the longer the time period, the more important is this half-way point when it is reached.’ In a later chapter, I will walk you through an example of the 1929 Great Depression high and the final low in 1932 for the Dow Jones. The significance of the 50% level between those two points was immense – it was only until that point was crossed (in 1952 nearly 20 years later) that a new major bull market in US equities started. This highlights the importance of identifying the level that balances price in a market.
Major, minor and intermediate price ranges In all of your analysis, there will be a major, a minor and an intermediate range of price or time period of significance. In general terms, the longer the price range (as measured by the period of time in between the high and low points) the more significant is the range. A major price range is determined by taking the yearly (or cyclical) high and low of a major bull or bear market and calculating the distance the market has travelled in price. A major price range will therefore be significant for calling other significant market tops and bottoms (such as a yearly high or low). I will show you an example of a major price range at work, shortly. An intermediate price range is determined by taking a significant high and low within a major cycle and calculating the distance between those two prices. Intermediate ranges will sometimes call significant (yearly) tops and bottoms, but will often determine turning points within a section of the market. Additionally, the price retracement of an intermediate range will help you determine the strength of a market, and whether the next section of the market is likely to exceed the previous one.
Minor price ranges will use a much shorter period of time, typically over a number of days. Retracements within a minor price range will often allow you to determine other minor tops and bottoms within a move, but will provide you with very useful targets for trade entry and exit points. I regularly use minor price retracements in conjunction with my ‘trading to Time’ Tool in order to establish tradeable turns within a market. I will also show you an example of intermediate and minor price ranges working in the market shortly. Finally, intra-day movements can be used to determine micro price ranges. Just as a major, minor or intermediate price range is calculated, micro ranges can be determined using intra-day charts (such as an hourly, 15 minute or even a 4 minute chart). Micro ranges can be especially useful to zoom in when you are looking to take a trade by providing you with very close entry points. As an example, if my time calculations are indicating a top due on say 16 September, I will often zoom in and use the 50% or 61.8% retracement of an intra-day chart to help me determine a trade entry point.
Determining major ranges – S&P 500 (using yearly lows)
Start- 1576
The following chart is a weekly bar chart of the S&P500 illustrating the importance of our three key price retracement levels using the major range that was made between the October 2007 bull market high at 1576 and the March 2009 bear market low at 667. Notice how the market retraced and found resistance almost exactly at the 61.8% Fibonacci level to form a significant top. It then found future support and resistance on our two other key price retracement lines, further illustrating the significance of these major price retracement levels in the market.
61.8% - 1229
50.0% - 1121
38.2% - 1014
Determining minor ranges – S&P 500 (daily chart) The same application of calculating price retracements using ranges can be made using a shorter time frame and by using minor tops and bottoms within a section of the market. In the next chart, I have again used price action in the S&P 500 off the October 2011 low, and have used the minor tops and bottoms that subsequently occurred to calculate future price support points over a shorter time frame
End - 667
OCT 2007
Determining major ranges – S&P 500
MAR 2009
OCT 2011
Illustration 4.01
You will notice that the market found support at on one of our three key price retracement levels at every single turning point during the bull market campaign from 2011 to 2013. This provided five distinct buying oppor tunities that would have kept you long and with the main trend using this single technique alone!
1800 – E 1700 –
E 50.0%
1600 – 38.2% 1500 –
S
E E
1400 – 61.8%
S
END
1300 –
61.8%
S
1200 – S
61.8% 1100 – START
1000 – Jul 2011
Determining minor ranges – S&P 500
Dec 2011
May 2012
Oct 2012
Mar 2013
Aug 2013
Illustration 4.02
Gauging the strength of a market using price retracement points Earlier, I highlighted that the 50% level acts as a significant level to watch within all markets. The half-way point acts as a balancing level for price, often giving you an indication of the underlying strength of a trend. You should always watch to see how deep the corrective retracement (or counter-trend price move) is within a market to determine the overall strength of the main trend. When the market is able to find support or resistance before the 50% level is reached, you can normally expect it to continue to new highs (or lows) when the market resumes its trend. The opposite is generally true when a market retraces more than 50%. This is a potential sign of trend weakness. If the 50% level is broken, I will then pay particular attention to the 61.8% level within a price retracement. I have found that if the market cannot find support at the 61.8% level it is an indication that the previous trend is weakening and running out of puff.
To illustrate how the 50% level can be used as a gauge of strength, the following chart depicts the weekly price action of the S&P500 off the March 2009 low and the subsequent major high that it made in late April 2010 (an intermediate price range). As we established in section one earlier, once it became clear that the March 2009 low was in and the trend was up, the primary objective would be to ensure you are trading with it and identifying buying opportunities along the way. It can be seen from the following chart that the market moved almost exactly to our first key intermediate price retracement level at 38.2%. Once this point held as support, using our general rule we figure that the new bull market underway has strength, and that the April 2010 high should ultimately be taken out. The following chart reveals how the future price movement unfolded in exactly that way.
Important note:
As a general rule, a market is more likely to continue moving with the current trend if it is able to find support or resistance before the 50% level is reached.
1800 –
Once the 38.2% price level held, we knew the bull market underway had strength and that the April 2010 high should ultimately be taken out. 1600 –
1400 –
APRIL 2010 HIGH 1200 –
1000 –
38.2%
< 50% (STRENGTH)
50.0%
= 50% (BALANCED MARKET)
61.8%
> 50% (WEAKNESS)
800 –
MARCH 2009 LOW
600 – Jan-08
Aug-08
Mar-09
Oct-09
Gauging the strength of a market – S&P 500 Example
May-10
Dec-10
Jul-11
Feb-12
Sep-12
Apr-13
Nov-13
Illustration 4.03
Chapter Five – How to use previous tops and bottoms to forecast future prices
One thing which has consistently stood out to both myself and Bob during our years of analysing and trading the markets, is the way in which the price of a future top or bottom has, in some way, a direct mathematical proportion to a previous top or bottom. Gann described this in some detail in both Chapter IV of his book How to Make Profits in Commodities and in Chapter IV of his book 45 Years in Wall Street. I think both of these chapters are worthy of further study and attention. On page 30 of his book 45 Years in Wall Street, he outlines:
‘One of the greatest discoveries I ever made was how to figure the percentage of high and low prices on the averages and individual stocks. The percentages of extreme high and low levels indicate future resistance levels. There is a relation between every low price to some future high price, and a percentage of the low price indicates what levels to expect the next high price.
There are only nine pages contained in chapter IV of 45 Years in Wall Street, but these are nine pages well worth the read. I think reading this chapter with a historical price chart of the Dow Jones in front of you is the best way to truly get a proper appreciation of what Gann is trying to tell you. When doing so, you should perform the calculations yourself and identify the tops and bottoms he is referring to.
Dow Jones index 1921 to 1953 (45 Years in Wall Street) To speed up the process for you, illustration 5.01 outlines a number of the significant turning points in the lead up to the Great Depression high in 1929 and the subsequent low which followed in 1932. In 45 Years in Wall Street, Gann refers to a number of other significant tops and bottoms when arriving at his calculations. The price points I am about to show you below however illustrate the power of this Trading Tool using only one major low as a reference point. The monthly bar chart starts using the extreme low in the Dow Jones Industrials index which occurred at 63.9 on 24 August 1921. (As an aside, please remember that date of 24 August for the time being – you will see it popping up again a little later). Gann often referred to extreme lows or highs as the points which ended or began multi-year long bull or bear markets.
In his book, Gann described the 1921 extreme low as 64 points exactly. We will use 63.9 in our calculations, as that was the actual price of the low according to my data. We use that low and then calculate repeating ranges of that price to give us future price targets to act as support or resistance in the market. A 100% repeat of the low gives us 127.8 (or 2 x 63.9) as a future resistance level to watch. The cycle low for the year in 1943 came in at 128.9. Whilst it doesn’t look like a huge turning point on the following chart, it did see the end of a pretty significant run down off the 1943 high which ran for a period of 138 days – so it is certainly not a point to be sneezed at. Next we figure that 300% of our 1921 low (or 3 times 63.9) gives us a price objective of 191.7. You will notice that a ver y major cyclical top formed in 1937 around that resistance level at 195.6. Moving on to our next price next target using that that low, we calculate 400% of 63.9 which equals 255.6. Notice how the yearly low in 1953 came in at a price almost within one exact point of this price.
At this point in time, I would like to take you back to our chapter earlier on price retracements. The Fibonacci level of 61.8% between the 3 September 1929 top and the 8 July 1932 low is 254.1. So our 1953 low was also within a single point of that! In other words, our calculations are telling us that the 254 to 255 price region is a significant place to look for key turning points in the future. Remember, we are using calculations which called a low in 1953 from a price that occurred 30 years earlier, using techniques from a book that was published in 1949! The next percentage level off our 1921 low is 500% which gives us a price target of 319.5 to watch. If by now, you are beginning to expect this tool to call market turning points every single time, I can understand why, but I think that might be expecting a little bit too much. In any event, this price did not produce anything of major significance, so I have left it off the charts.
Finally, we go to our next major percentage level at 600% of the 1921 low which gives us a price target of 383.4 to look out for. In his book, Gann calculates other price resistance levels using other previous tops and bottoms to give him the additional price targets of 384.75 and 388.50. Averaging out the three of those prices together give us a forecast price of 385.55. The highest point at which the Dow Jones sold to, marking the top of what I consider to be the greatest stock market high of all time, was 386.10 – so our calculations are less than one point out!
Remember, we are using calculations which called a low in 1953 from a price that occurred 30 years earlier, using techniques from a book that was published in 1949!
450 –
3 SEP 1929 TOP = 386.1 400 –
600%
350 –
300 –
1946 TOP = 213.4
400%
250 –
10 MAR 1937 TOP = 195.6
15 SEP 1953 LOW = 254.4
200 –
300%
150 –
200% 100 –
50 –
8 JUL 1932 24 AUG 1921
LOW = 40.6
LOW = 63.9
1920
1922
1924
1926
1928
1930
1932
1934
1936
Using previous highs and lows to forecast price – Dow Jones Index example
1938
1940
1942
1944
1946
1948
1950
1952
1954
Illustrati on 5.01
Before we go any further, there is something important which I would like to point out from chapter IV of 45 Years in Wall Street which I apply to my own analysis of the markets. In his book, Gann outlined that:
i.
The most important resistance level is 50% of any high or low price. 1
ii. Second in importance is 100% on the lowest selling price on the averages or individual stocks. 2 iii. You must also use 200%, 300%, 400%, 500%, 600% or more depending upon the price and the Time Periods from High and Low. 1
‘For example 50% x 386.1 High = 193.05’ (Which called the 1937 top)
2
‘For example 2 x 63.9 Low = 127.8’ (Which called the 1944 low)
In the examples earlier, we used exact multiples only of a significant market low to define future market support or resistance points. In his book however, Gann also referred to the using the divisions of 25%, 12.5% and even 6. 25% from major highs and lows as third, fourth and fifth in importance.
A problem which both Bob and I have found in using so many percentages is that you end up with too many support or resistance points on your chart. In our experience, this overcomplicates the exercise and can cause confusion, making it difficult to know which price targets to actually trade from. If, for example, you are calculating each 25% division, you will end up with 4 series of price targets before you get to the next multiple. If you are using two or three major lows to calculate your price objectives, then you will double or triple the amount of price targets… and so on. As a basic rule, I stick mainly to exact multiples of previous highs and lows, and will occasionally use 150%, and 250% multiples (and so on) if my analysis can handle it.
Using the 50% rule to project the price of a future top or bottom Before we get on to a present day example using the S&P500 index, I would like to revisit a point I made earlier about using the 50% division of a high or low price. One way to apply this technique is simply to take the price of a major market high and divide it by two in order to calculate the future prices of potential tops or bottoms. Using the 1929 high as an example, 50% of 386.1 equals 193.0 – which is within three points of the 1937 high of 195.6. Using 50% of a major price range is another level that should be watched for future price support and resistance to occur. For example, following the 1929 high of 386.1, the Dow Jones made its final Great Depression low in 1932 at a price of 40.6 – this gives us a very important price range of 345.5 to calculate future support and resistance. The 50% price retracement point using this range is 213.3 – within a fraction of the yearly high in 1946 at 213.4.
The significance of these 50% points in the market after such a major period is immense.
500 –
450 –
Following the significant losses made during the Great Depression, the Dow Jones took over 14 years to make back half of what was lost, when it reached its high in 1937 at a price of 195.6. It was almost 20 years until prices were able to make a clear break of the 50% balancing point between the 1929 high and 1932 low, when the US stock market was finally able to break into a new bull market and past the prices reached in 1929. In the case of the Dow Jones, the 50% price held for almost 20 years and it was only until prices were able to make a clear break of that balancing point, that the US stock market eventually went on to break through the high that was made in 1929.
3 SEP 1929 TOP = 386.1 400 –
START 350 –
300 –
1946 TOP = 213.4
250 –
50% 200 –
150 –
100 –
8 JUL 1932 LOW = 40.6 50 –
END 0– 1922
1924
1926
1928
1930
The 50% Rule – Down Jones Index
1932
1934
1936
1938
1940
1942
1944
1946
1948
1950
1952
1954
1956
Illustrati on 5.02
Worked example – S&P 500 index (1978 low and the 1987 to p)
History will go down as showing that the top of the S&P500 before the 1987 crash came in at 338 – within a fraction of our forecast resistance points. Incidentally, the date of the high in the S&P500 occurred on 25 August 1987. I hope that date sounds familiar!
I now want to demonstrate to you how the principles described to you earlier continue to work in today’s markets. The first chart starts with the yearly low in the S&P500 index made on 1 March 1978 at a price of 86 points. The next multiple of 86 (or 200% of it) gives us a price target of 172. The yearly high in October 1983 came in at a price of 173. Moving on another 86 points gives us a future price target of 258. The yearly high in 1986 came in at a price of 254 on 27 August 1986. If you recall, I asked you to remember the date of the 1921 low we used in the Dow Jones example earlier which occurred on 24 August. This is a very significant time for the Dow Jones, with many significant turning points in the market occurring on or around that date – this is a time you should always watch on the Dow Jones index. (But more on that later). Next we calculate 4 times the low of 86 to give us a price point of 344. An exact repeat of the October 1983 high of 173 also gives us a price target of 346 (173 x 2). By these calculations, we should figure that the area of 344 to 346 will be met with heavy resistance.
400
25 AUG 1987 TOP = 338
86 x 400% = 344
300
27 AUG 1986 TOP = 254
86 x 300% = 258
10 OCT 1983 TOP = 173
200
86 x 200% = 172
100
1 MAR 1978 LOW = 86
1978
1980
S&P 500 index (1977to 1990)
1982
1984
1986
1988
1990
Illustration 5.03
How to forecast future prices using previous highs and lows – S&P 500 index (2000 to 2009) I now want to fast forward a bit in time and look at some of the most recent market price action in the S&P500 to demonstrate that the approach of using previous prices to forecast future tops and bottoms is still relevant today. The following chart of the S&P500 covers the price action between 2000 and 2013. We start by taking a look at the tech-bubble high reached on 24 March 2000 at a price of 1553. In the earlier example, we were using the first three multiples of the 1978 low in the S&P 500 to calculate the yearly highs in 1983, 1986 and 1987. Contiuning the sequence higher, we would then calculate that 18 x 86 = 1548.
1978 low x 18 1987 high x9
average of two forecasts M ar ch 2 00 0 ( te ch -b ub bl e h ig h)
Alternatively, you could use the October 1983 high of 173 (which is derived from the 1978 low) and multiply that by 9, which will you a target price of 1557. In any event, the average of those two prices gives us 1553. The price of the techbubble high for the S&P500 reached in March 2000 was 1553 – exactly. Following the high in March 2000, US equities moved into a signficant bear market. Earlier, I highlighted that Gann noted that the most important price level to watch out for is 50% of any high or low, so following those principles, we would now be looking to see if our 50% price point can provide any support to the falling stock prices. Calculating that 50% of the 1553 high gives us a price of 776.5, we would be wise to watch and see what prices do at this point.
= 86.0 = 1 54 8 (price forecast one) = 173.0 = 1 557 (price forecast two)
= 1553 (average price forecast) = 15 53 ( ac tu al )
The following chart highlights a series of three lows (or triple bottoms) which occurred following the tech-wreck bubble in 2000. The first of those significant lows occurred in July 2002 at a price of 776 –an exact 50% division of the high which the low was coming from. The extreme low price in October 2002 occurred at 769, whilst a subsequent low occurred in March 2003 at 789. The average of these three prices was 778. We would then figure that the the price average of 778 becomes an important price to work with. A repeat of this range (or 2 x 778) provides us with a target of 1556. The market made a significant high on 16 July 2007 right on 1556 and sold off heavily, before recovering to rally to its final high in October 2007 at a price of 1576.
Projecting these numbers for one more cycle gives us a future price of 2328 (or 3 x 778) to look out for. Whenever you see numbers working to provide future levels of price support and resistance, it always pays to keep a close eye on them in the future. Not only will you notice those numbers working to produce future prices, but you will also see those same numbers appearing as significant calendar day time counts in your analysis.
789 low x 200% = 1578 1600 –
OCT 2007 TOP=1576
JUL 2007 TOP=1556
MAR 2000 TOP = 1553
773 pts DOWN 1400 –
1200 –
1000 –
JUL 2OO2 LOW=776
800 –
MAR 2003 LOW=789 OCT 2002 LOW=769 MAR 2009 LOW=667
Average of 3 bottoms = 778 200% x 778 = 1556
600 –
400 – 1998
1999
S&P 500 (1998 to 2010)
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Illustration 5.04
In my view, the brilliance of the discovery by Gann that the future prices of tops and bottoms are directly related to previous tops and bottoms lies in its simplicity. There is no need for a Nobel Prize award winning mathematical algorithm to forecast the price– all it needs is the use of a simple calculator.
Chapter Six – Price projections
Fibonacci extensions In the same way, that we use the levels inspired by Fibonacci in our price retracements, his sequence can be applied to project future movements of price to identify where the next section of the market is likely to end up. A Fibonacci extension is simply created by using a range as a reference point (for example using the range created by a low to a high), and then projecting that same range off the next major turning point (in this case, the next low). The same levels used in your Fibonacci price retracement sequence are then applied to the extension.
The key levels I use in my Fibonacci extension analysis are as follows: 38.2%, 50.0%, 61.8%, 100%, and 138.2%, 150% and 161.8% I do however believe there is validity in exploring the 23.6% and 123.6% extensions in your analysis if you believe your trading can handle the additional price levels.
In the next example, our reference range starts with the 10 October 2002 low in the S&P500 index, marked “A”, to the following cycle high on 11 October 2007 which is marked “B”. We then calculate our Fibonacci extensions using the next major low which occurred on 6 March 2009 marked “C” – or in other words, “start”, “end”, “extend”. As with Fibonacci retracements, extensions of price can be used to work with major, minor and intermediate price ranges. The greater the price range, the more significant is the Fibonacci extension in calling future support and resistance points in price. When I see Fibonacci extensions reacting off a 100% level, I will watch these closely to produce a change in trend. This provides me with not only a place to look for market turns, but an excellent opportunity to hedge an existing position.
Pay close attention to the 100% extension level which is the most important – this is where the previous price range (or cycle) will have repeated itself
Sections of the market and repeating Fibonacci extensions of price I continue to be amazed by the frequency with which future movements in price are either an exact repeat of a previous movement of price (or very close to it). In his works, R.N. Elliott observed that it will often be the case that two out of the three waves with the trend will be equal in either time or price. I have certainly found this to be true a number of times. Watching for repeating price movements applies equally to major ranges which occur over a number of years as well as intra-day movements which occur over a matter of minutes or hours. I have seen markets move with such precision, that sometimes I expect (unreasonably) that each and every move must unfold with such repetition. There is certainly a level of restraint required to ensure you don’t hold out for those extra couple of points to achieve perfection.
When price ranges repeat in conjunction with our other price indicators (particularly with a key retracement level), it is a good sign that the price move is over and there will be a change in trend.
2000
161.8% 150%
138.2% END 1600
B 100%
1200
61.8% 50.0% 38.2%
800
A
START
C
EXTEND
400 2001
2002
6.01 Fibonacci E xtensions
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Illustration 6.01
Australian SPI futures and repeating Fibonacci extensions The following is an example of the Australian equities market futures contract known as the Share Price Index contract, or SPI, for short. The reason why I am using this as my first example is because this was my first serious real time experience observing prices repeating in this market. Illustrations 6.02 and 6.03 represent the daily price action in the SPI over the period between 2000 and 2001. During that time, prices essentially traded in a sideways for an extended period. I have highlighted three key sections to demonstrate the price symmetry in each of the major moves that occurred in the market over that period. The first price movement was the one which saw a run down from the top of 3398 on 24 August 2000 to the low of 3170 on 22 September 2000 – a price move of 228 points. The price range 228 was already significant to watch in this market, as it represented one half of the all-time low that the SPI futures contract ever traded, which was the low on 1 March 1983 at a price of 458.
Following the 22 September low, the market ran to a yearly high of 3414 on 7 November 2000. This completed a larger overall move from a major low which occurred on 22 March 2000 at a price of 2957. The price range between these two market turns (3414 minus 2957) equalled 457 points – exactly two times the 228 point move down which occurred just before it and a repeat of the all-time low price for the SPI futures market. From the 3414 high, we would then figure that the market might have another 228 points of downside in it. This would give us a target of 3186 to look out for. Not only would this represent a repeat in price, but it would also mean the market is finding resistance at the 50% level of the range between the 3414 high and the 2957 low.
Start – 7 Nov 2000 high at 3414
Previous major range down = 228 points
Price target calculation: 3414 minus 228pts
Start 7 Nov 2000 high at 3414 Previous major low on 22 March 2000 at 2957
Price range = 457 points
I can recall very distinctly watching this unfold as it did. Not only was price working in exact proportions, but so too was time.
50% price retracement
Price forecast (one) = 3186
Price forecast (two) = 3185.5
The actual price of the 21 December 2000 low was 3186 – exactly!
After the 3186 low, the market continued its sideways action and reached a double top in February and March of 2001 at a price of 3371. Once the double tops had confirmed, we would calculate (yes, you guessed it) that the market could move down another 228 points. This would give us a price target of 3143. The range marked as section “C” highlights this price action and that a low was made on 22 March 2001 at exactly 3143. This low was further supported by a double bottom on 29 March at 3144. I can recall very distinctly watching this unfold as it did. Not only was price working in exact proportions, but so too was time.
(I will show you why in a later chapter where I will demonstrate how easy it was to forecast the dates to watch for the changes in trend). The set-ups in this sequence of price movements were simply just too good to be true. I remember Bob being so confident that the market would reach 3143 that he put a call into his broker to place a buy order at exactly 3143 more than a week before it happened. At the time, the market was trading about 3300 and I remember Bob telling me that he was laughed at on the other end of the line when he placed the call.
To finish this analysis of the 2000 and 2001 markets, I think it is also important to highlight that following the 3143 low, the next major price move in the market was a range of 345 points up to the 2001 yearly high of 3491 on 29 June. Interestingly, the range up of 345 points is almost exactly a 150% repeat of our previous working range of 228.
3600
3500
24 AUG 2000 TOP = 3398
7 NOV 2000 TOP = 3414 1 FEB & 8 MAR 2001 DBL. TOP = 3371
3400
3300
3200
3100
3000
2900
17 APR 2000 LOW = 2957
22 SEP 2000 LOW = 3170
21 DEC 2000 LOW = 3186
23 MAR 2001 LOW = 3143
228 pts DOWN
228 pts DOWN
228 pts DOWN
A
B
C
2800 Jan-00
Mar-00
May-00
Repeating Price – ASX SPI 200 Futures
Jul-00
Sep-00
Nov-00
Jan-01
Mar-01
May-01
Jul-01
Sep-01
Nov-01
Illustration 6.02
3600
228 x 150% =342 3500
228 x 200% =456
29 JUN 2001 TOP=3491
7 NOV 2000 TOP=3414
3400
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23 MAR 2001 LOW=3143
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Illustration 6.03
How I forecast the S&P500 top in September 2012 – To the exact point
In late 2011, following the birth of my fir st child, I spent a considerable amount of time analysing the markets whilst taking some time off work. As the newborn was keeping both my wife and I up for most of the night, I would often find myself awake late, giving me time to analyse the market in between the changing of nappies and feeding. It was at this stage that I was asked by a close friend of mine to provide a forecast for the S&P 500 index. I hadn’t provided a written forecast for a number of years, but both Bob and I were still making accurate calls during that time – we just weren’t going to the effort of putting these calls in writing. I had been watching the price action in the Australian market very closely, which had traded nowhere near as strongly as US equities had over the last two and a half years. I had already figured with Bob that the major bear market low was in. Certainly this was the feeling by the majority over in the United States, but in Australia, our investor base was still very sceptical. Bob in particular was looking out for the next buying opportunity in the Australian market for a while now, and had pencilled in October to November 2011 as the key time to watch.
The following chart, which compares the relative price performance of the S&P500 with the S&P ASX 200 illustrates why so many Australian investors were still nervous about buying equities. Both the US and Australian markets had experienced sharp sell-offs from the highs they had reached earlier in the year following the European debt crisis. This simply added to the existing investor nervousness here in Australia.
As the area of the bank that I was working in did not provide stock specific advice, the piece was sent out to a number of financial advisers as a ‘Thought Leadership’ article. The basis of the analysis was that the premium available from the dividend yields on the ‘big-four’ Australian banking stocks and our two leading mining shares, when compared to cash, were near historic highs.
Whilst US equities were sitting on gains of over 60%, Australian equities were trading at just a touch over 20% off their March 2009 low. To put all of that into perspective, the all-time high in the Australian benchmark index before the global financial crisis started, occurred at a price around 6850. In October 2011, we were trading back at levels close to 3850, so investors who bought at the top were still nursing losses of almost 50% four years on.
My research had shown that whenever this premium was greater than 500 basis points for banking stocks and 200 basis points in the mining shares, anyone who invested in those stocks and held for a period of twelve months or more, would have seen large gains with a 98% to 100% historical probability of profit.
Both the cycle analysis that Bob and I had done had convinced us that October 2011 was the time to buy. Such was my confidence in this that I researched and wrote an article on behalf of the investment bank I was working for presenting some fundamental reasons why now was a good time to consider investing in Australian equities again.
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Since I wrote that article (up until the end of 2013), the average return on the big-four banking stocks (including dividends) has been enormous. Interestingly, the date of the actual market low in 2011 was 4 October and my Thought Leadership article was published only two weeks later on 19 October – maybe it was just lucky timing! Getting back to the main point, following the birth of my daughter, I began studying where the S&P500 was likely to be headed next. I had seen that the market had moved up 807.5 points in its previous run from the 10 October 2002 low to the 11 October 2007 high so I began by using that as my starting point.
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OCT 2011 LOWS
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Nov 2009
Why October 2011 was the TIME to buy
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Illustration 6.04
The next obvious port of call would then be to take that major five year range and add it to the most recent bear market low in March 2009 (or in other words, using a Fibonacci extension of 100%). This gives us a price target of 666.8 + 807.5 = 1474.3. I had nominated this exact price to friends and colleagues as an area that I felt the S&P500 was going to reach, well before the event. As the following chart will show, on 14 September 2012, the S&P500 market made a significant high at 1474.5 before a six percent pull-back.
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In my email, I wrote:
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11 OCT 2007 TOP = 1576.1 1600
“Now that we are at the 1474 level], it might be a good time to take out some put option protection at these levels given volatility is cheap to protect the portfolio from a possible decline”
14 SEP 2012 TOP = 1474.5
807.5 pts UP 807.7 pts UP
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10 OCT 2002 LOW = 768.6
6 MAR 2009 LOW = 666.8
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Repeating Price – S&P 500 Example one
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2013
Illustration 6.05
Although the market had hit my price target of 1474 exactly, my strength indicators at the time were telling me that it would eventually trade at higher prices. In the next chapter, I will show you how I was able to determine this and why I was confident higher prices would follow. In actual fact, I had outlined this in an email to friends and colleagues only two trading days following the 1474 high.
In that that same same email, email, II also also wrote wrote that: that:
“[Whilst] I have had an overall short bias on the market for a little while since the S&P500 hit my 1474 target exactly, I think it is important to realise that when positioning yourself, I am not expecting the world to cave in (although it could happen), but rather I am just waiting for the market to present a good buy opportunity which will allow many people to take a long term buy and hold position and ride things higher into 2013. In other words, I am not a buyer at these levels (at 1474), but I think people will be rewarded if they have the patience to wait for a pull back... The market has made some strong gains, and this further supports the case that we could be ready for another bull run.”
The Fibonacci extension at 10 0% rightfully proved to be the opportune price to hedge, before a six percent fall provided the buying opportunity I was looking out for. Later on in this course, I will walk you through the series of forecasts that I had written at the time, which identified the opportunity to sell at the 1474 top, and the buying opportunity and price targets which soon followed.
S&P500 off the 4 Oct 2011 low – minor price range Fibonacci extensions A final example I would like to share with you to demonstrate how price can move in both major and minor moves again uses the S&P500 index. The series of smaller price ranges starts by using the same 4 Oc tober 2011 low and the 1474 top we just described earlier which ended on a major repeating price range of 807 points. In the following chart, I have highlighted the equal price movements which produced ranges between 107 and 110 points. Separately, you will see that I have also highlighted three larger ranges of 218 points, 220 points and 208 points. Just in the case the significance of these numbers is lost to anyone, 50% of 220 equals 110. So the smaller price ranges and the larger price ranges are geometrically connected within the same bull market cycle.
In the example earlier, I showed you how I had calculated 1474 as a significant resistance point. In actual fact, I had initially been looking for the resistance in the market to occur between 1440 and 1474 when I first made that forecast in late 2011, more than a year in advance. When I saw the price ranges of 108 and 218 points emerging however, I took the liberty of revising that forecast to between 1474 and 1485. I had figured that the third range leading up to the 14 September 2012 high could end on another price move up of 218 points, which would take us to 1485. The actual high as we know however came in right on 1474, repeating the major price range of 807 to the exact point.
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Repeating Price – S&P 500 Example two
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Illustration 6.06
Repeating ranges in percentage terms It would be remiss of me to not to mention that repeats in price can occur not only in terms of the number of points moved up or down, but also by the percentage change in price off a high or a low. I have found that repeats in terms of points (or ticks) are more common in stocks, stock indices and commodities, so I tend not to focus on repeating percentages when conducting my analysis on those markets. One observation that both Bob and I have found however over the years, is that some markets tend to favour repeating ranges in percentage terms more so than they do in points. A prime example of this is the Australian to US dollar foreign exchange market, where I have seldom seen repeating price moves when measured in points.
S&P500 repeats in price range percentage Notwithstanding the above, to keep things consistent, the example below illustrates how repeating percentage ranges have occurred in the S&P500 market. The following chart reflects the price movements in the bear market from the March 2000 tech-bubble top to the following October 2002 low. I have identified three significant counter-trend rallies in this analysis. The first rally culminated in a move of 235 points, which was repeated in price by the second counter rally of 232 points. The third range up however is repeated in terms of percentages, with an almost exact counter-trend rally between the second and third moves of 24.6% and 24.4%, respectively. Relating this analysis back to our earlier discussion on overbalancing price, once we saw the market rallying off the October 2002 low by more than 24.6%, it was a sign that the trend had changed and the bear market was over.
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Repeating Price (Percentages) – S&P 500
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Illustration 6.07
Chapter Seven – how to determine the strength of a move
In chapter six when we discussed how to use price retracements in our analysis, we discussed the concept of using the 50% level as a balancing point to determine the underlying strength behind the market and whether one could expect a resumption of the trend to continue. In the previous chapter, we discussed how the use of Fibonacci price extensions in your analysis could allow you to not only project future market tops and bottom, but more importantly to use those levels as an area to take out profits or hedge your position. In this chapter, I will share with you the simple tools I have adapted to determine whether a repeat of a previous r ange is likely or unlikely.
Boxing a price move and the use of pitch lines One of the techniques which I rely on quite frequently in my analysis is to compare the current move in the direction of the market to the one which just preceded it. To do this, I simply create a box over the most recently completed move, and duplicate it onto the start of the next move so that I can watch it unfold. In the following example, I am using the first major section of the market that was completed off the October 2002 low of 769 (marked as point A) which ran to the March 2004 top of 1163 (marked as point B). The actual move between the high and the low was 394 points in 512 days. This allows you to create a box over this price movement with a diagonal line across. To measure the next section of the market, we simply duplicate the original box using the next significant low which occurred in August 2004 at 1061 (which is our starting point, marked as point C). In other words, we simply create another box that measures 512 days across and 394 points up in price off our new starting base.
Important note:
Knowing whether a move is going be larger or smaller than the one before it can certainly add some value to your trading and investment decisions.
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Determining the strength of a move –S&P 500 Example one
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Illustration 7.01
When constructing the new box as illustrated in the previous example, I also measure the diagonal line across within the box. This is represented by the thick dark blue lines. This is what I refer to as the “pitch line”. The pitch line is very useful, as it tells you the velocity in which the first section of the market ran (in this case it ran at 0.77 points per day = 394 pts / 512 days). I will nearly always compare what the next move is doing against the same pitch line in the new box. If the market is trading at or above the pitch line in the next box, it is indicating that it has enough momentum behind it to repeat the price range of the original move and within the same original time frame (in this case 512 days). If the market is having difficulty trending consistently above the pitch line (as it was in the previous example), it suggests that a repeat in the previous range of 394 points is unlikely to be achieved within the 512 day time from off the p oint C low. I also like to pay close attention to identify any “fall away” moves when conducting my box analysis.
When I see a fall away beginning to occur, it is an early warning sign that the 100% Fibonacci extension level is not likely to be achieved, and a reason to revise your trading strategy and profit targets. The same fall away pattern occurred again in the S&P 500 in 2010. Whilst the following chart looks very similar to the one preceding it, I can assure you that they represent two completely different periods of time in the market.
Important note: A “fall away” move like the one in the example earlier, occurs when a move is running at or above the original pitch line early on in the box, but then trades for a number of consecutive days below the pitch line, before losing momentum altogether and fading below it.
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“fall away” 1100 416 days 1000
1 JUL 2010 LOW = 1011 START NEW BOX
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6 MAR 2009 LOW = 667 Jun-09
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Determining the strength of a move –S&P 500 Example two
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Illustration 7.02
The Barillaro Angle One of my own adaptations of market boxes is to use them to determine overbought or oversold situations. In the examples above, I referred to the Pitch Line as the diagonal line between the start and end of the box. In the case of the first example, the Pitch Line running from the October 2002 low ran at 0.77 points per day. In my experience, I have found that creating a line to follow twice the angle of the Pitch Line (or what Bob began to refer to as the “Barillaro Angle”) has been a very useful tool. We have both found that it is a useful tool which can allow you on a regular basis to determine the following things:
1. Firstly, if a market is consistently trending at or above the Barillaro Angle, it is suggesting that it will ultimately complete more than 100% of the previous range in price within the original time frame (in a number of cases, much sooner) 2. Secondly, I often find that the Barillaro Angle will be a useful angle to call a significant top or bottom within the move. I am therefore always on the lookout for the market making a turning point on this angle in conjunction with one of my other indicators.
The following example uses sections of the market which occurred during the bull market between October 2002 and October 2007. It uses the 13 August 2004 low to the 8 May 2006 top as the reference point to create the box, and then duplicates it from the 14 June 2006 low. You will see that the market spent a considerable amount of time trading above the Barillaro Angle early on in the movement, suggesting that it was going to achieve more than 100% of the previous range. This it most certainly did, achieving that price within a much shorter period of time than it took to complete the first reference range. Note also, how the Barillaro Angle also called the significant top which occurred on 16 July 2007, before a sharp retracement. This is just one of many examples, where I have seen the market behave in this manner.
BARILLARO ANGLE forecasted the Jul 2007 TOP
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Price above the BARILLARO ANGLE early in the move indicates move likely to exceed 100% of previous range 1500
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END 8 MAY 20 06 TOP = 1327 1300
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The Barillaro Angle
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Illustration 7.03
The Barillaro Box – My own trend tracking indicator Over the years, both Bob and I have experimented with various forms of repeating boxes (or squares) over the market. The objective, was to find something which we felt worked consistently but was also simple to apply. In the end, we found that using a simple ‘crossed box’ in conjunction with the Barillaro Angles, created a fairly reliable method to measure the strength of a market and identify zones for taking profit (or identifying overbought situations). As neither of us are the creative type, we started referring to these as Barillaro Boxes. To construct a Barillaro Box, I simply repeat a previous box (or square) in the same manner which I described earlier. Once your new box is in, I then create a diagonal line running from the top left hand side of the box to the bottom right, which, when drawn in conjunction with the Pitch Line, leaves you with a ‘crossed box’. There is a degree of simplicity when using a crossed box, as the very mid-point of the cross gives you the exact point where both time and price in the Box are at their 50% level, or balancing point. In this case it really is a matter of ‘X marks the spot’. I think it is a useful habit to get into to always check where the market is at this 50% point – if the market is trading above this point, you can expect it to go further. If the market is at or about this point, it is in balance and the second half of the box needs to be watched. If the market is trading well below this point, it is indicating that a repeat of the previous range within the box time frame is unlikely.
Once I have crossed the box, you are left with four distinct sections in the box formation. I have labelled these in the following chart to illustrate the point. From there, I then like to draw in my Barillaro Angle as my future guide to watch out for an overbought situation. This should then create two new zones – one above the Barillaro Angle, which I refer to as the “Profit Zone” and one below it, which I refer to as the “Fall Away Zone”. This can be seen in the following chart illustration. I will always check the market when it begins trading into the Profit Zone to look for an area to hedge a position or lock in some profits on an existing position. What the Profit Zone is telling you, is that the market is running at more than twice the speed of its previous move and within less than half the time period. The Profit Zone therefore gives you a ready-made tool which can identify areas to take some quick profits off the table. It also pays to keep close attention once the market crosses over from the Profit Zone into the Fall Away Zone. Once price moves into the Fall Away Zone, you should stay on guard and look out for a counter-trend reaction. When I analysed the US equity markets in 2011, one of the very first things I did was create a Barillaro Box to compare the October 2002 and the March 2009 lows. I used the S&P500 October 2002 low as my starting point, and boxed the move to the October 2007 high. Earlier, we described how this market moved upward to complete a major range of 807.5 points over 1827 calendar days.
As the March 2009 was well and truly by then, a major reference point, it therefore became the low to use in order to re-create the box of 807.5 points in 1827 days. You can see how the Barillaro Angle again called a significant market top which occurred at 1371 – almost to the exact point. The previous chart also shows why it was apparent to me in 2011 that the mar ket looked like it was eventually going to exceed the bull market range of 807.5 points (made in 2002 to 2007) and move towards much higher prices. The fact that it had spent almost the entire time trading above the original Pitch Line indicated that it was going to run more than the 807 point range which preceded it. The power of the Barillaro Box can also be seen by creating one over the current market. Using the March 2009 low and the May 2011 high as the reference point, you should go and create a Barillaro Box using the October 2011 low. As at the time of writing (January 2014), the S&P500 has incredibly spent most of its current move trading right along the Barillaro Angle in this new box, almost as if the angle was acting as a predictive flight path for the current market.
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significant tops and bottoms forecast by the BARILLARO BOX 1800
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Illustration 7.04
Chapter Eight – Time and price angles
Up until now, the previous sections of this course have focussed on how to incorporate price into your market analysis. In this chapter, we begin our first introduction to the use of time in your analysis. We discuss the many other powerful uses of time in Volume 2 of this course. One of the tools which Gann is most famous for is the discovery of his “Gann Angles” or what many refer to as “Gann Fans”. I prefer to describe this tool as Time and Price Angles, as that is exactly what they are. Gann had discovered that the use of fixed angles could be projected into the future at a pre-defined rate. The use of these angles allows you to identify significant points in the market where both price and time are in a direct geometric relationship. However, what is truly powerful about the discovery of this tool, is that unlike trend lines or Pitch Lines which require two points in the market to calculate the angle, Time and Price Angles can be calculated to determine future points of support and resistance as soon as a significant top or bottom has been formed.
How to construct a Time and Price Angle A Time and Price Angle is simply created by drawing a line up or down from a major top or bottom using a defined movement in price for each individual time period. For example, a 1x1 Time and Price Angle would represent one unit of price (eg a point, cent or tick) for one unit of time. A series of angles can be created by varying the price and/or time movement. A 2x1 angle for example would represent two units of price for each unit in time. Likewise, a 1x2 angle would represent one unit in price for two units in time. Generally, I use the following price unit ratios for different markets when constructing my
Time and Price Angles: Stock indices
1 full index point = 1 unit
Stocks
1 cent = 1 unit
Currencies
1 pip = 1 unit
2x1
How to construct Time and Price Angles - Example In the graphic below, the solid line represents a 1x1 angle moving 12 units up in p rice over a period of 12 units in time. Notice how this creates a horizontal angle which is in exact proportion across the chart, making it an exact 45 degrees. In his writing, Gann often referred to this angle as the “45 degree angle” – it was just his way of describing a 1x1 line. The line above the 45 degree angle represents a 2x1 Time and Price angle as it has moved up 12 units in price over only 6 units in time. Similarly, the line below the 45 degree line is a 1x2 angle, moving only 6 units in price over 12 units in time. Each unit in time can represent either a trading day, a calendar day, a week, a month, an hour or even a minute if you are planning to do intra-day analysis.
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Time & Price angles
Illustration 8.01
How to know which high or low to start the angle from In my opinion, there is a very basic rule to determine which point to start your angle from.
The more significant the high or low, the more significant is the angle that it creates. I like to use the major cyclical highs and lows which occur at the start and end of a bull or bear campaign as my Price and Time Angle starting points. Next I like to work off any significant tops which occurred immediately before the final high, or any significant bottom which occurred before an extreme low was reached. Thirdly, I will always keep an eye out on other significant tops and bottoms within a major cycle and look to see if the market is working to a particular Time & Price angle off those reference points.
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Where to start your Time & Price Angles – S&P500 (2006 to 2013)
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Illustration 8.02
How to know which type of angle to use The next important factor to determine is which angle out of the multiple combinations of time and price to use. As I like to keep my analysis simple, I stick predominantly to the 1x1 angles, which means that each unit in price is in equal proportion to time. My general rule is therefore:
Start your analysis using the 1x1 angles – this represents a 100% geometric relationship between price and time which is the most important. In some situations, the use of a 1x1 angle might be impractical, particularly if it moves too quickly for the market you are analysing. This has been my experience in the S&P500 index, where the use of a 1x1 angle will often move too quickly for prices to keep up. In these situations, I use the next most significant angle which is the 1x2 as this represents a 50% geometric relationship between time and price. A further point which you will need to determine is whether to use a calendar day count or a trading day count. A calendar day count means that the Time & Price Angle will move one unit in price for each calendar day, so it will continue to rise even on weekends. A trading day Time & Price Angle on the other hand will only move up in price whenever the market trades on a particular day, so they will move slower than a calendar day angle. The following example of the most recent market action in the S&P500 index will show this.
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Time and Price Angles – trading day v calendar day angles (S&P500 index)
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Illustration 8.03
Time & Price Angles – working examples S&P500 (2006 to 2013)
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In an earlier illustration, I provided you with a series of points which are useful starting points to run your Time and Price Angle analysis.
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The following chart should demonstrate to you how powerful Time & Price Angles can be in forecasting future points where prices will meet support and resistance. I have used both calendar day angles (represented by the solid lines) and trading day angles (represented by the dotted lines). Notice how in a number of situations, a Time and Price Angle off one of our starting points provided support or resistance to call a future market top or bottom. Additionally, in a number of cases, both the trading day angle and the calendar day angle produced results.
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Time & Price Angles – working examples S&P500 (2006 to 2013)
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Illustration 8.04
Always run your Time and Price Angles off major yearly tops and bottoms and continue to watch these angles years into the future to provide future support and resistance.
Active angles An active angle is what I refer to when a Time & Price angle has worked to produce a significant top or bottom. Whenever you see an active angle working, it is worthwhile to keep running this angle into the future. Often you will find that a series of turning points will occur at different points on these active angles. I will rarely look to use angles outside the 1x1, 1x2 or 2 x1 in a market unless I have identified an active angle working in some other geometric relationship (eg 1x4 or 4x1).
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Active angles in the S&P500 market between 2009 and 2013 – example The following chart is a 1x1 trading day angle illustration, highlighting how intermediate turning points within a market can be used to run Time & Price Angles that will determine future support and resistance and other minor tops and bottoms. I have simply chosen this time frame as it is the most recent and reflects the movement in the market up to the time of writing. There are countless examples from a number of different markets which I could have used to demonstrate the power of this tool. Notice that there are a number of active angles within the bull market run off the March 2009 low and the next major low within that cycle in October 2011. These active angles should therefore continue to be watched into the future.
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Active angles in the S&P50 0 market between 2009 and 2013 – example
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Illustrati on 8.05
Master Square Calculators Before completing this section on Time and Price Angles, I want to provide a brief overview on the Gann Master Square Calculators. I am aware that Gann used these Master Squares in his own analysis and that a number of Gann traders use them as a primary tool in their trading decisions. Both Bob and I have spent considerable amounts of time studying these Master Squares. We have seen them work in the markets therefore neither of us would deny they are a valid tool. Personally however, neither Bob nor I explicitly use these Master Squares when constructing a forecast.
There are a few reasons why I make that statement and why I have qualified it with the word ‘explicitly’. Firstly, there is no denying that Gann did in fact use these Master Squares extensively in his analysis. This is one of the primary reasons I believe they get so much ‘air time’ in many of the current books written about Gann theory. At this point, I think it is worthwhile remembering that when Gann operated in the markets, he did so without the aid of computers and this was a key reason why he was so meticulous about keeping his charts to the same time and price scale. Gann created templates of these Master Squares on transparent pieces of paper so that he could apply them over all of his charts. By drawing these Master Squares on a transparent sheet, Gann had a ready-made tool that he could simply re-use over and over in his analysis – hence, why he referred to them as M aster “Calculators.”
These Calculators would have saved Gann an enormous amount of time back in his day, and it is one of the reasons why I believe he discussed them so often - simply because he would have used them so frequently. The second point I wish to make is this. Each of the Master Calculators are constructed to geometric proportions of time and price reflecting the way Gann looked at the markets and the many tools he used. The Master Calculators actually analyse a market using Gann Angles, divisionsof time and price, repeating time frames, repeating price ranges, and even Gann’s fourth dimension – all in the one box! Although Bob and I won’t actually use a Master Square overlay in our analysis, we are in fact using many of the tools embedded within them to perform our forecasting. To illustrate the point, the following chart is the Master Square of 52 which Gann commonly used on his weekly charts. This Square allowed Gann to divide up the year into the key geometrical proportions that he thought were the most important – in particularly divisions by halves and quarters. Each week represented one unit of time in the Square of 52 – and naturally, as there are 52 weeks in one year, this Square was how Gann divided up the year. A Master Square is simply constructed by moving up one unit of price and across one unit in time and connecting the dots to create a Square.
You can use any range of price or period of time to construct the Square calculator. Gann often referred to the Master Squares of 52, 90 and 144 – as these can be applied to any market. Equally however, you can create a Master Square using the price of a major high or low for a particular market. For example, the March 2009 low of 667 could be used to create a Master Square measuring 667 days across and 667 points up.
How to create a Master Square The following diagram highlights the construction of a Square of 52 and how it moves up 52 units in price (on the y-axis) and 52 units across in time (on the x-axis). Gann then created diagonal lines to create the Calculator within by linking up key points within the Square that had significant geometric proportion. Essentially, these were done by drawing horizontal lines linking:
2 5 1 5 0 5 9 4 8 4 7 4 6 4 5 4 4 4 3 4 2 4 1 4
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The zero point (or start) of the square to the end points in the Square – these create the thick horizontal red lines (or “cross”) within the Square
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ii. Each half-way point to its next half way point – these are seen by the thick horizontal blue lines in Calculator, creating a “square” within the Square (or divisions of price and time in quarters); and
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iii. Each half-way point to an end point in the Square – these are seen by the black horizontal lines, creating “triangles” within the Square (or divisions in thirds).
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Illustrati on 8.06
How to use the Master Squares Gann would normally overlay these Master Squares by placing the “zero” point over a major top or bottom. In the case of a low, this would be by placing the bottom left hand corner of the Square over the low price, and in the case of a top, by placing the top left hand corner over the price of a top. The Square would then give you the key Gann Time & Price Angles and divisions of time and price to look out for. Once you have come to the end of the Square (for example, 52 weeks across), you simply duplicate a new square starting from the point where it ends, and repeating this into the future. The Square of 52 was made for a weekly chart, and this is where it works best. The Square of 90 is good to use for forecasting longer term cycles via monthly chart, and the Square of 144 for shorter time periods (for example, on a daily chart).
Important note:
A full and proper appreciation of all of the Gann tools will help you enormously if you wish to incorporate Master Squares in your analysis. Once you have completed the remaining chapters of this course, you may then wish to revisit this section on Master Squares – I am sure by then you will be able to look at these Master Calculators in a much different light!
TRADING TOOL BOX TWO
HOW TO FORECAST PRICE
1. Price retracements
2. Using a previous high or a low to forecast price
3. Price projections
• Always calculate your price retracements using the major,
• The price of a previous major
• Price extensions are calculated by
market top and bottom will often
using a previous price range as a
minor and intermediate price
calculate support and resistance
reference point and repeating that
ranges
levels for future tops and bottoms.
price range from the following
– Major price ranges – use the cyclical or yearly highs and lows (from a weekly chart) – Minor price ranges – use the
• Use exact multiples of a previous low to calculate future prices – 100%, 200%, 300% and so on. • Calculate 50% of the price of a
market top or bottom... Start. End. Extend. • The 100% Fibonaccci extension (or a repeat of the price range) is the most important.
minor tops and bottoms that
previous major top to determine
occur within an overall section of the market (from a daily chart)
levels of support for market
• Often watch for a change in trend
bottoms on the way down.
to take place once 100% of the
• Simplify your analysis. Use the 38.2%, 50.0% and 61.8% as the three key levels to determine your price retracement points.
previous range has been reached. This is particularly important if it coincides with a major price retracement level.
Keep the analysis simple. Use the major divisions of price – 50% and 100% are the most important. Fewer tools will simplify your analysis and give you a higher probability of determining a change in trend when you see them working together.
4. Strength ind icators
5. The Baril laro Box
6. Time & Pr ice angles
• Always watch the 50.0% price retracement level as a guide of
• Use the Barillaro Box and establish the Barillaro Angle.
• Begin your Time & Price angles off significant market tops and
strength in the market. • Retracement s that are less than 50.0% indicate the trend is strong. • Retracement s of more than 61.8% suggest the main trend is weakening. • Use your Pitch Lines to determine the likelihood of a market exceeding 100% of the previous range. • Markets trading above the Pitch Line are more likely to exceed 100% of the previous moves than those which don’t.
If a market is consistently trending
bottoms – the extreme high and
above the Barillaro Angle, it is likely to exceed 100% of the
low are the best places to start.
previous range and within a shorter time frame. • Keep an eye on the Barillaro Angle in a fast moving market. It will sometimes create an angle for significant market tops or bottoms to form. • Identify your Profit Zone and Fall Away Zones. The Profit Zone is a good place to take early profits or hedge your position.
• The more significant the top or bottom, the more significant is the Time & Price angle. • Start your analysis using 1x1 angles only. These represent a 100% geometric relationship between time and price which is the most important • Always watch your Active Angles as they will often call other future tops and bottoms
S E C T I O N T H R EE
In my view, making fewer but longer term trades is the easiest and most profitable way to trade the markets. – It also requires far less work!
The best rules for trading
In this section of the course I will share with you some mechanical points of entry and exit to make your trading decisions more clinical, as well as five simple rules for trade psychology and risk management. Up until now, we have focussed on how to put together a very accurate forecast using price techniques. This should, by now, have armed you with the tools to identify “where” is the best price to buy or sell. Putting together a price forecast however, is only one part of the equation. How you go about trading it is a completely different story! In my view, making fewer but longer term trades is the easiest and the most profitable way to trade the markets. It also requires far less work. Trading the markets however is a skill that requires you to master the techniques of trade entry and exit, as well as the psychology associated with each of those steps and everything else that happens in between.
Chapter Nine – Trading psychology and risk management
I am confident, that with practice, the techniques I have shown you in this course can make you a much better trader. But make no mistake, there is no single system or no single trader who has a fool proof system for trading. The reason for this is that markets are essentially made up by an aggregate of human emotion. When people are feeling good about things, the markets will generally trade up. When things are not looking so optimistic, human emotion will tend to see markets trade down. Human emotion however is the one element that not even the most sophisticated computer algorithms or ‘black box’ market systems have been able to predict. This is particularly so near market tops and bottoms where human emotion is at its greatest, whether it be the irrational exuberance at a market top or the fear and panic that often ensues at a market low. Whilst winning trades will provide you with a huge adrenalin rush, it is important too to realise that losing trades are also inevitable. And it is the losing trades that will test your mettle. If you do however find yourself on the end of a losing streak, then my advice would be to come back and visit this section of the course first before any of the others. I can almost guarantee that the five rules I am about to describe below will take on a whole, new meaning.
Five simple rules for risk management Most of the trading books and courses which I have read (the good ones at least, that is) include a section on trading psychology and how human emotion has such a large impact on actual trading decisions. Make no mistake, this is certainly true. Putting your own money at risk will affect your trading decisions in a way that you simply cannot simulate through paper trading a market. I have found however, that to properly learn how to control your emotions in your trading and investment decision-making, you need to experience the process first of making an actual trade. You will never fully prepare yourself for the rollercoaster ride of emotions that go with trading no matter how many trading psychology books you read.
Please do not interpret that as me dismissing the need to have the right trading psychology to beat the markets. It is absolutely necessary. In my view however, the subject matter of psychology is something best left to be explained by an expert in psychology. Don’t worry, there are plenty of books out there on the subject.
In addition, each individual person has their own temperament, their own risk appetite and their own differing desires for profit. And whilst I am more than happy to share my own personal experiences with anyone who asks, just because that was my experience, it does not necessarily mean it will be the same as yours. At the end of the day, the objective in trading should be getting yourself profitable. To do this, you need to make sure you have more winning trades than losers, and that your winners are bigger than your losing ones. Having said all of that, there are a few simple rules that you should know which I do think are absolutely necessary to control your trade decisions and keep your investment capital intact.
The greatest lesson you will ever get about trading psychology will come from your own experience in trading the market.
Rule 1:
Rule 3:
Never enter a trade without placing a STOP LOSS order
Don’t be greedy when it is time to take profits
Entering a trade without a stop loss is the cardinal sin in trading. ALWAYS identify your stop loss position before you enter a trade and stick to that price level religiously. Your stop loss is not only there to quarantine your risk, but it represents the point where the market is telling you that you are wrong. As the saying goes, ‘don’t leave home without it’!
Identify where you want to take your profits at the beginning of the trade and do not change your mind unless the market is giving you a very good reason to do so. The trick here is to avoid getting emotionally attached to a winning trade. Not wanting a good feeling to end when you should in fact be taking your money and banking it is a common trap. Avoid the expectation that you need to get every last cent out of a move – even though your forecasting will at times pin point turning points to the exact price – as trying to squeeze out the last cent will often be the most costly.
Rule 2: Hope is for dopes If you are uncertain about a trade and begin to “hope” that you are right, reassess your position as it is probably a good indicator that it is time to get out. This is particularly so if you are still holding on to a position even though your Stop Loss indicator has been reached.
Rule 4: Minimise your risk wherever possible The market will often give you an opportunity to take some profit off the table and reduce your exposure. One of the lessons Bob learned in his trading was to take profits at points where it either covered his position or significantly minimised his risk. Not only will this help you sleep better at night, but it will allow you to execute your trade decisions in a much more clinical manner and with less emotion. It also has the added benefit of significantly improving your strike rate between your winning trades and losing ones.
For example, assume that you are looking to trade a recent low in your favourite stock after it reached your price target of $20.00. Your price forecast is now suggesting that the stock may make a move up to $22.50 per share. Let’s then say that you entered your trade by purchasing 2000 shares of stock at $20.40 after your signals confirmed that a potential low was in place. Your identified stop loss should now be underneath that low of $20.00 – for this example, let’s call it $19.90. That gives your trade a risk of $0.50 per share if you are wrong, or a total risk exposure on your 2000 shares of $1000. (Note, we will cover trade entry and exit points, as well as stop loss positions in the next chapter).
The effect of this strategy on your trading decisions can be enormous, as it can completely change your trading psychology. By booking profits on half your position, you are minimising your potential for loss, and putting yourself in a position to hold on to your trade for further upside with significantly reduced risk. In the example above, if the stock ultimately does move higher to hit your price target of $22.50, it would mean that you would stand to make a $2.10 per share profit on the remaining 1000 shares long position you hold (or $2100 gain) in addition to the $500 profit you booked earlier. Not only have you made a healthy profit, but you have done so by minimising your risk.
If the stock then makes a move to $20.90, you would be sitting on a paper profit of 50 cents per share, or $1000. By using this price level as an opportunity to take profits on half your position (ie by selling 1000 shares), you can book the 50 cent gain (or a $500 profit) and keep a remaining 1000 shares long position in the stock. At this point, even if the stock trades back down and triggers your original stop loss position at $19.90 (or creating a $500 loss), you have put yourself in a position where overall, you will not lose on the trade (putting aside for the moment any brokerage or trade commissions). Sounds simple, right!?
The other significant advantage of this type of strategy is that it can significantly reduce your number of losing trades, thereby improving your overall win to loss ratio. In the next chapter, we will discuss how to identify price entry and exit levels that allow you to identify trades where your potential for profits is greater than your potential risk. The benefit of this approach is that by taking trades where your average profits are greater than your average losses, even if you have a win to loss ratio of 50:50, on an overall basis you will still be profitable.
For example, if you made 5 winning trades where the average profit was $2.10 per share (or $10.50 in total profits) and you made 5 losing trades where the average loss was $0.50 per share (or $2.50 in total losses), on an overall basis, from your 10 trades you will have made an $8.00 gain. Now that might sound to you like it is absurdly simple, but that’s because it actually is!
Rule 5: Keep your trade sizes consistent Another one of the easiest mistakes to make is to increase the amount of capital you are putting at risk on a single trade. Whilst this might sound obvious, breaking this rule is actually easy to do, particularly when you have all of your Trading Tools confirming your market top or bottom and you have convinced yourself that there is no other possible outcome other than for your forecast to be right! There is no worse feeling than to have made four or five profits in a row, and then doubling or tripling up your bets only to have all those profits wiped out by the next trade. Equally, you will need to avoid this temptation if you have been on a bit of a losing streak and you are looking to make up all those previous losses on the next trade. A word of advice – Don’t try it. Taking on trade positions that are too large and that will end up causing you to be hurting badly (emotionally) if you take a loss is something that you should avoid at all costs. Trading is a tough enough game emotionally and psychologically as it is. There is no need to give yourself added pressure on a single trade by over committing yourself to one particular trade or position. My advice – AVOID THE TEMPTATION FROM OVERTRADING.
Only once you have built up some considerable profits, would I suggest that you start thinking about increasing your contract sizes. For example, if you are starting with a trading account of $10,000 and are taking trade sizes of 10 contracts for each trade, maintain those trade sizes until your trading account hits a milestone of (say) $20,000. At that point, you could look to increase your trade sizes to 15 or 20 contracts as this would be proportionate to your account balance. The worst thing to do is to take a 20 contract position if your account has gone from $10,000 to $5,000 as that is just amplifying your risk.
Important note:
Keep your trade sizes consistent and avoid the temptation from over trading. Once you have built up considerable profits, then start thinking about increasing the size of your trades.
Chapter Ten – The best trading entry and exit points
Earlier I mentioned, that in my view, making fewer but longer term trades is the easiest and most profitable way to trade the markets. I simply cannot emphasise the relevance of that statement, and this is certainly what Gann meant when he described trading the “long swings” as the most profitable way to trade. In an earlier section of this course, we discussed how to identify the definable waves or sections of a market that all major bull or bear campaigns move to. Whilst it may have appeared unassuming at the time, that chapter of the book is actually one of the most important. When trading, your primary objective should be to ensure you are trading with the trend and capturing as much of the move in each of those sections as possible. Put simply, if the market is in a major bull campaign, you should be looking for one or two buying opportunities to trade each section using your Trading Tools – this is where you will make the most profit with fewer trades and the least amount of work. The Trading Tools however are also useful indicators to identify counter-trend trades within a major bull or bear market. As highlighted in earlier chapters, you can also use your Trading Tools to determine points in price and time where you can either hedge your longer term position with the trend, or for the more aggressive trader, to actually take an against the trend position. In this chapter, we describe how to do both.
Rules for trading with the trend The following levels should be used as a guide to determine your points of exit and entry when you are taking trades that are in the same direction as the main trend. The percentage levels below refer to the expected price range for each section of the market you are trying to trade using our Fibonacci Extensions discussed in an earlier chapter. The same principles can be applied to make shorter term trades over a smaller time frame, including intra-day trades.
Rule 1: When to enter • 0% to 38.2% Is the place where you should look to initially enter your trade • Consider placing your stops 2.0% above / below below the market top/bottom you are trading.
Trades entered within this point will give you a profit to risk ratio of approximately 2 to 1. 1. For example, if we are looking to trade a price range of 100 points, then we ideally want to have entered before the 38.2 point mark is reached. If the price move hits our profit target of 100, then we have made a 61.8 point profit on a risk of only 38.2. In an ideal situation, trades entered into before the 23.6% Fibonacci level provide the best set-ups as they come with a much lower level of risk and a higher profit to risk ratio of more than 3 to 1.
Rule 2: Reduce your position (the ‘break-even’ rule) • At ‘break-even’ ‘break-even’ consider reducing your position to minimise risk
Traders who have a lower risk appetite may look to use this area as a place to reduce their position or cover their trade to avoid a loss. For example, if the range you are seeking to trade is 100 points, and you entered at the 23% point in the range, then you would have a total risk position of 25 points (including 2 points for your stop). Once the market reaches the 50% level, by reducing half your position, you will have taken profit of 25 points on half your trade, whilst maintaining a risk exposure of 25 points on the remaining position. At this point, your overall overall position is at a ‘break-even’. For those who have a lower tolerance for risk, the break-even point will mean you should end up having more winning trades. The flip side to this is that you may see yourself taking profit off the table too early and missing out on some further gains. Using the break-even rule therefore will depend on each individual trader and their own desired level of risk appetite.
Rule 3: Risk management • At 61.8% consider moving your stops higher/lower to 38.2%
Once the trade has crossed and reached the 61.8% mark, you typically do not like to see it moving back below the first of our key Fibonacci levels. By moving your stops to to 38.2% (which is the place at which you should have entered your trade), you should no longer be in a losing position. Not only will this help improve your winning average, but it should help you mentally to stick with the trend and ride the winning trades.
Rule 4: Profit taking levels
Rule 5: Additional profit taking levels
• At 100% consider taking profits or hedge your position
• At 123.6%, 138.2%, 150.0% and 161.8% consider these as areas for taking profits, if the indicators are telling you a move of more than 100% is likely
The 100% level marks our trade objective, and is where we should look to thank the market and take profits off the table. The exception to this rule is if your indicators are telling you that a move beyond 100% is likely (see rule five). If this is the case, you can then use the 100% level as a place to hedge your position – for example through a put option strategy or writing some covered calls if you are long the market.
Markets will often give you clear signals when a new move is more likely to exceed the previous move in terms of price. In situations like this when a market is trending strongly, you will leave some considerable upside profit on the table by exiting completely at the 100% level. You should refer to the Barillaro Box and the Price Retracement trading tools as your gauges of strength to determine if such a move is likely. In these situations you can use a trailing stop strategy under each Fibonacci level to lock in profits. This will allow to continue riding the market for further gains until your trailing stop is hit.
2000
WITH THE TREND TRADE (LONG POSITION)
Risk (38.2%) = 975 Minus 667 (or 208pts) Reward (100%) = 1474 1474 minus 975 (or 499pts) Reward to risk ratio: 2.4x
1750
OCT 2007 TOP = 1576
1500
100% = 1474 (PROFIT TARGET)
PROFIT RANGE
1250
61.8% = 1166 (MOVE STOPS)
1000
38.2% = 975 (ENTER TRADE BY HERE)
750
TRADE ENTRY RANGE OCT 2002 LOW = 768
MAR 2009 LOW
0.0% = 667 (INITIAL STOP LOSS)
500 2 00 1
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2 0 04
2 00 5
The best trade and exit points (trading with the trend)
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2012
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Illustration 10.01
Rules for trading against the trend (counter-trend trades) A more cautious approach should be adopted when attempting to take a trade against the main direction of the trend – after all, in these situations you really are attempting to swim against the tide. A counter-trend trade occurs when you are looking to trade short off a top in the middle of a bull market or go long off a bottom in a bear run. The latter in particular can be a hair-raising experience – particularly in a fast moving bear market, as you don’t want to be caught out trying to catch the falling knife. I therefore adopt a slightly different approach when determining rules to follow for against the trend exit and entry points than those used for ‘with the trend’ trades. The price levels below refer to moves using Fibonacci Retracement levels of the previous ‘with the trend’ range.
Rule 1: When to enter • 0% to 23.6% is where you should look to initially enter your trade • You can place your stops 2.0% above/below the market top/bottom you are trading. Notice how the entry point for a counter-trend trade is tighter than that of a with the trend trade. This is purely designed to minimise your risk from the outset.
Rule 2: Covering risk • At ‘break-even’ reduce your position and use the ‘break-even’ rule where possible. The half-way point of any price retracement is the most important area where price support or resistance will occur. This level should therefore be used as an area of caution and monitored closely to either cover risk or reduce it.
Rule 3: Risk management • At 61.8% retracement or 100% of the previous counter trend move • Aim to take profits at these levels where possible. When taking a counter-trend trade, I will often look at the 61.8% price retracement level as an area to take profit or exit the trade. Equally, I will use 100% of the previous counter-trend move as an area to set exit targets. For example, if I am trading short in a bull market, and the previous price reaction down was 50 points, I will also look to see a repeat of that move off the current top I am trying to trade as a potential exit level. I will pay particular attention to this level when it also converges with either a 50% or 61.8% retracement.
A final word The trade entry and exit techniques described above are designed to make your trade decisions more clinical and to develop areas that allow you an opportunity to ensure that your gains from winning trades are greater than the losses on your losing ones. This will mean that even if you have a 50:50 win ratio, you should still end up being a profitable trader!
1550
COUNTER-TREND TRADE (SHORT POSITION)
Risk (23.6%) =1474 Minus 1425 (or 49pts) Reward (61.8%) = 1425 Minus 1346 (or 79pts)
1500
END = 1474 0.0% (INITIAL STOPS)
TRADE ENTRY RANGE
1450
23.6% = 1425 (TRADE ENTRY)
PROFIT RANGE
1400
50.0% = 1371 1350
61.8% =1346 (PROFIT TARGET)
1300
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START = 1267 1200
1150
TRADE ENTRY RANGE 1100
1050 Apr-11
Jun-11
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Feb-12
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Illustration 10.02
CONCLUSION
If you’ve made it this far, you have now been privy to the most consistent and reliable price forecasting techniques that I have discovered working in financial markets.
Congratulations, you’ve made it!
I am genuinely thrilled to have shared this journey with you and I hope that you have had a bit of fun along the way. Whilst the Trading with the Time Factor course comes in two parts, each part is designed to standalone from the other. If volume one of this course has been of interest, then I can assure you that volume two will absolutely blow your mind. Whilst our focus up until now has been about price, volume two continues our journey into time, and teaches you the techniques that will help you identify “when” is the best place to buy and sell the markets. In volume two, I reveal some of the most practical, but powerful techniques for forecasting the exact date and time of future market tops and bottoms. I hope you decide to continue on the journey with me. It will, without doubt, change the way you look at financial markets. Until next time.
