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April, 2014 4:56 AM

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Predicting price movements using Gann Theory

Predicting price movements using Gann Theory

William Delbert Gann worked to develop a method of trading the markets that would enable him to predict price movements.

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By AAP 21.09.2009

Very few technical analysts get passionate or emotional over a 20-day moving averages, Bollinger bands or MACDs.  Yet bring up the subject of WD Gann and the gloves are off.

Gann seems to split technical analysts between those who love his theories and those who don’t.  So I decided to check out what it is about WD Gann and his theories that put technical analysts firmly in one camp or the other.

William Delbert Gann was born in Texas in 1878, and died in 1955. Like many thousands of people before and since, he worked to develop a method of trading the markets that would enable him to predict price movements.  And, just like many other theories, these were based primarily on the timing of entry and exit points.

You wouldn’t think that would be enough to fire up the emotions more than any other kind of analysis.  But Gann’s theory differed from others in one important aspect.

Gann believed that time was a more important element in predicting stock movements than price.

So, let’s take a look at his two main methodologies – Swing Charts and Gann Fans.  

First Swing Charts.  Take a look at the two diagrams below.  Believe it or not, they both portray the same price action within the same timeframe.  The one on the left simply shows a bar for each daily trading range.  The one on the right shows the same chart but using Gann’s Swing Chart methodology.

Source: ASX 

The ASX website explains, the Trend Line Indicator moves to the high for the period on an up day and keeps moving higher until a reversal is recorded.  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.  This trend following means the method is most commonly used for breakout trading.

The second method is the Gann Fan.  Here’s an example of it on a AUDUSD price chart...

Source: CMC Markets

Again, according to the ASX website, first you identify the last major low, major high or both. Then you 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 1x2 line and then the 2x1 line. In fact the lines extend from 1x8 through the 1x1 line to the 8x1 line and total nine lines in all.  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.

Each of these fan lines provides either support or resistance depending on which line the market is tracking. According to the theory, the market will tend to follow one particular angle until it is broken and then look for another Gann angle to track.

In the chart above you can see the Aussie dollar has mostly remained above the 1x2 line and created a support level – that is the line immediately below the 45-degree 1x1 line.

When the stock is trading near the support level this represents a strong buy signal.

But to get more info I picked up the phone and spoke to two technical traders.

First I spoke to general manager of Melbourne based trading firm Consensus Financial and former national board member for the Australian Technical Analysts Association, Scott Blair.

According to Blair, defining Gann’s theory is difficult.  As he sees it, this is because the theory has been interpreted, re-interpreted and built upon by numerous people over the years.  “It’s a bit like open-source software for computers.  People take it, adapt it and try to improve it.  That means you have to go right back to the original text to figure out exactly what Gann was all about.”

Despite this, Blair believes it’s the breadth of Gann’s work that appeals to many different traders, “from geometry for those inclined towards mathematics, to natural laws for the more enlightened trader.”

Steven Galjaardt, technical analyst at Your Trading Room based in Brisbane also believes diversity is one of the reasons for the success of Gann’s theories.  For instance Gann used five elements when determining the ‘setup’ for a trade.  These were: time, price, pattern, position and volatility.

As Steven Galjaardt explains, “Gann trading can be as simple or as complex as you want to make it.  You can either use Gann’s methods on their own, or use them to enhance an existing a personal trading strategy.  For instance, using Gann angles to measure the strength of a move.”

But as with any kind of stock analysis, whether it’s technical or fundamental, the important thing is to find a method you’re comfortable with.  And more importantly, that you understand.

 

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