One of the simplest of Gann's methodologies is a complete trading system using swing charts. Swing charts are most commonly formed from daily charts, but he also worked with two day swing charts and even more complex three or five day swing charts.
The construction of a swing chart results in what Gann called a Trend Line Indicator. Using the high and low for the period, whichever exceeds the previous day becomes the Trend Line Indicator.
There are four classifications of day types all 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
The Trend Line Indicator moves to the high for the period on an up day and keeps moving higher until a reversal is recorded. A reversal would come in the form of a down day or an outside day. If the market has three up days in a row that will convert into one vertical line covering the range to the high and then a horizontal swing line.
The swing line swings to the low on a down day, and continues until the next reversal. In this case, an up day or possibly an outside day, depending on when the low was made.
In the event of an outside day in an uptrend, if the high is made before the low on the day, the swing indicator is pushed to the extreme for the day, in the direction of the trend and then reversed to the low of the session. This is a reversal. If the low is made before the high then the Trend Line Indicator just keeps moving higher, to the high for the session.
An inside day has no impact on the Trend Line Indicator.
There are two charts below. The first (fig 63) displays a normal daily chart that captures a correction rather than a trend. Although it looks like an up trend may be developing toward the end of the sample.
The next chart is a result of applying the swing chart rules. The result is a compressed chart, relative to the raw data above. It reflects well the fact that wing charts remove the constant time interval from the data. Each vertical line represents an indefinite period of time. It could be one day or as many days as the market keeps making higher lows.
This is a really good trend indicator, as the name suggests. Like any trend trading system the possibility exists for being whipsawed, but this can be reduced somewhat by applying the filter, that best suits both the market and the individual trader's style.How to use swing charts
Once the chart has been constructed the buy and sell signals generated by this trading system appear quite clearly, as do the stops. But first we need to establish some more definitions.
Tops and Bottoms
The trend line indicator only changes direction when we have an opposite day to the trend. That is on a down day in an uptrend or on an up day during a down trend. This doesn't necessarily mean we've made a top or bottom. A top or bottom is not declared until the reversal takes out the previous opposite swing peak.
Perhaps the best thing about swing charts is that they clearly identify trends in the market, removing a lot of noise that might normally hide a trend. A trend is defined by progressive swings in the same direction. There are two up trends displayed in the chart below and while the first one suffered from a reversal the second is yet to be terminated.
If the trend is up, which is signalled by consecutive swing points progressively higher, a buy signal is generated when a new high is made following a swing bottom.
Conversely a sell signal is generated during a down trend when a new low is made immediately after a swing top. New sell signals are generated every time we make a reversal followed by a new low. The sell signal is generated as we make the new low.
The above chart has all the possible buy signals marked and the only sell signal generated in the sample. The sample is from the same data as the previous figs 63 & 64.
Breakout traders will recognise this system as a breakout system and that is exactly what it is. However it does filter out a lot of unnecessary noise that can plague a breakout trader and it relies on the establishment of a clear trend from those filters before issuing a new signal. Many techniques can be applied to the swing chart itself, such as trend lines or Elliot wave counts.
Nevertheless it has the same pitfalls that all trend following systems have, the most obvious being the requirement of a trend to capitalise on its profitability. Needless to say in the absence of a trend, in a corrective market, it can result in a series of losses.
W D Gann postulated a theory that there exists a relationship between price and time that finds balance at specific points in time. The basic premise is that the market will make tops at multiples of the all time low and the timing will be quantifiable from the value of the all time low. It also applies to a lessor extent to major lows and highs.
It follows then that the market will track specific time versus price relationships from major lows and major highs. Even minor lows and highs will follow similar time price trend lines.
Gann gave specific instructions on how to construct a fan. So let's start with a daily chart, the most common interval for Gann analysis. The time frame is not that important however the consistency of the interval is significant. First we should identify the last major low or major high or both. Let's assume it's a major low. We then draw a 45 degree line that increases by one unit of price for every one unit of time.
There are then the eight minor lines of the fan, starting with the 1*2 line and then the 2*1 line. In fact the lines extend from 1*8 through the 1*1 line to the 8*1 line and total nine lines in all, excluding the horizontal reference lines. As long as the scale is correct, that is one unit of price, this will be a variance from a 7.5 degree line to an 82.5 degree line.
The next most important lines are horizontal lines from the major high or the major low. These horizontal lines reveal potential turning points in the market wherever the fan angles cross the horizontal lines. The turning points are relative to the recent trend of the market.
Each of these fan lines provides either support or resistance depending on which quadrant the market is currently tracking. The market will tend to follow one particular angle and when that is broken looks for another Gann angle to track.
In the example above, the blue lines represent the 45 degree lines, that is, the one by one, due to the unusual scale these lines are marked as 1x10 lines on the chart. The pink lines are the 1x2 and the green lines 2x1. The black lines are 1x4 lines.
There are two vertical lines on the chart at 28Jun and 30Aug. They both occur as a result of a fan angle crossing the horizontal line emanating from the high or the low.
The first intersection signals the end of a small retracement and generates a sell signal counter to the trend, which was up at the time. That was followed by a substantial move lower and the resumption of the major down trend.
The next horizontal Gann angle cross on 30 Aug generated a buy signal as a result of the previous recent activity being down. Unfortunately that buy signal only produced two days of higher prices before the longer term bear market resumed.
Following the fan lines
The theory behind the Gann fan angles is that the market will tend to square itself in price and time. Therefore one would anticipate that price will gravitate toward the fan angle lines drawn from major tops or bottoms.
Quite often the move away from major tops or bottoms is extremely sharp and therefore lies in the 8x1 quadrant, which means it is moving 8 units of price per one unit of time. It won't be long until this steepness is broken and the market will then move through the 8x1 line and head toward the 4x1 line.
In the example above the Gann fan from the major top doesn't show the 8x1 line. It is clear however when price broke through the green line it moved to the blue line, failed to break it and then returned back to the green line to follow it lower. Once that was broken again price moved back through the blue line this time to touch the pink line before resuming the down trend and following the blue line lower. That blue line remained virtually in tact for the rest of the bear move until right at the end of the chart.
Gann did not provide a definitive trading system. And like all forms of analysis Gann's theories can be interpreted and applied according the analysts whim. Apparently he was quite secretive and forced his students to discover their own timing in the markets.