Trend Changes and Market Entries According to Gann

Terry Ashman (1998)

(Part M of Lesson 4 of online Manual included with HotTrader Software)
Here we will look at a number of Gann's rules for determining a trend change, and market entry
rules that Gann derives from these rules, that Gann speaks of in his various books. We will look at
market exits in the later lessons on putting it all together. We are going to start with Gann's bear
market "Short" entries first. These principles work with many markets including stocks and
commodities, but we will use stocks in these illustrations.
Going from a Bull to Bear market
In "How to Make Profits in Commodities", ("Form Reading" Page 46), W.D Gann says:
"SECONDARY RALLY OR LOWER TOP. After a prolonged advance when wheat or any
commodity reached final high and the Bull campaign is over, there is usually a short severe decline,
lasting anywhere from 1 to 2 and possibly 3 weeks or months. After the first sharp decline, the
market may remain in a narrow trading range for 10 days or 2 or 3 weeks, in some cases even
longer."
"After that, there is a SECONDARY RALLY, sometimes getting up near the OLD TOP and
sometimes not reaching it by many points. Going over past records you will find that a market
seldom fails to have this SECONDARY RALLY. When this SECONDARY RALLY comes, especially
after the TREND has TURNED DOWN, it is the safest rally on which to SELL SHORT, because the
decline is faster from that time on and rallies smaller."
Below is an example of this on ANZ Weekly chart. Note that this picture exactly fits Ganns
description - a break of the uptrend, then a large secondary rally followed by a reasonably fast bear
market decline with smaller rallies. (In order to effectively sell short ANZ, you would have to have
bought put options.)
A further point that Gann raises is this:
"Sell after the first decline exceeds the greatest reaction in the preceding Bull Campaign or the last
reaction before the final top" (Page 36 W.D.Gann Stock Market Course).
For an explanation of this, refer to the chart and commentary below
The size of reactions 1, 2, 3, 4 and 5 are marked with white lines. Reactions 1 to 4 occurred during
the bull market phase. Reaction 5 is the first decline that exceeds the greatest reaction in the
preceding bull campaign AND Reaction 5 exceeds the last big reaction before the final top (reaction
4) AND
Reaction 5 breaks the long term uptrend. (We've used a normal trend line to mark this, not the
break of a swing point. This is not what Gann taught but it is an alternative method that can be used
when you become skilled at recognising the trend channel.)
Places to Sell
Gann says that the safest place to sell is near, that is, just after, the top of the secondary rally -
assuming you can pick this. On Page 36 of the W.D.Gann Stock Market Course, Gann writes
"SAFEST SELLING POINT Sell on a secondary rally after a stock has broken the previous bottoms
of several weeks (Sell Point 2 just after "Top of Secondary Rally" in the picture above) or has
broken the bottom of the last reaction, turning trend down. (Sell Point 1) This secondary rally nearly
always comes after the first sharp decline in the first section of a Bear Campaign."
and
"Sell after the first decline exceeds the greatest reaction in the preceding Bull Campaign or the last
reaction before the final top." (Sell Point 1).
Important Notes
(1) If you are initiating new positions, that is, you are selling short or buying put options, you must
first determine your risk before entering the trade. Sell Point 1 may require a stop above swing
point 5. This stop is a fair distance away in this example and may be too big for your account size
or may cause a severe reduction in value of a put option if the market went this far against it. If this
is the case you do not take that trade.
(2) Sell Point 1 in this case could be used for exiting a long position, but not initiating a new short
position if the risk was too great, considering where you would put your stop - above point 5 top. In
other examples Sell Point 1 can be good for initiating a short position.
(3) Gann considers Sell Point 2 to be the safest, with a stop above the top of the secondary rally,
although this sell point can be difficult to define and is actually not used in his standard swing
trading method. There are methods which can be used to define it some of the time, which we will
look at in the screen movies.
(4) Sell point 3 is used in Gann's swing chart trading method and can be used subject to you being
able to define a point where you would exit the trade with a stop if the trade goes against you. Gann
says put a stop above the secondary rally.
Further example ...Study this carefully ..Acacia Resources Weekly with 2 Bar Hotswing
Explanation
The market falls, going lower than swing bottom 3, and the fall from swing top 4 to swing bottom 5
is larger than the range from swing top 2 to swing bottom 3, which is the last and largest reaction of
the preceding bull campaign. The fall below swing bottom 3 "officially" turns the trend down based
on Gann's rules so we are now looking for the "seconadary rally". Market does a "Secondary Rally"
making swing top 6. which is quite a bit lower than swing top 4. Gann says that the secondary rally
sometimes gets up near the old top (4) and sometimes does not reach it by many points. In this
case it didn't reach it by many points indicating potential weakness, which was bourne out by the
subsequent bear market. Gann's rules.
Entry Point 1 - Sell if long and sell short as market goes under swing bottom 3 subject to the risk
being acceptable if you put you stop above swing top 4.
Entry Point 2 - Sell Short as top of secondary rally turns down (swing top 6). Swing top 6 is a bit
above swing bottom 3 (remember "Support and Resistance in Trends").
Entry Point 3 - Sell short as the market goes below swing bottom 5, subject to you being able to
define a suitable stop point - a tick or two above swing top 6.
Here is what it looks like on a swing chart ...Carefully go through the preceding explanation and
relate it to the swing chart.
Going from a Bear to Bull market - Gann says
In "How to Make Profits in Commodities", ("Form Reading" Page 46), W.D Gann says ...
"SECONDARY DECLINE OR HIGHER BOTTOM. (Illustrated below with a chart of Goodman
Fielder). After a Bear campaign ends, whether it ends with a short severe decline, or declines
slowly making FINAL BOTTOM there is usually a quick rally lasting anywhere from a few weeks to
2 months. (Marked "Rally" on the illustration), Then the SECONDARY REACTION takes place,
(marked "Bottom 2 (Secondary Reaction)" on the illustration, which is a reaction back down again),
making a HIGHER BOTTOM and this bottom is the SAFEST PLACE TO BUY ..." (assuming you
can pick it, alternatively, you can buy as the market goes above the highest point made by the
"Rally".)
Note that this is exactly the same as the Bear Market explanation except that it is upside down. All
the same rules apply in reverse.
Places to Buy
On page 35 of the W.D.Gann Stock Market Course, Gann says
"SAFEST BUYING POINT: Buy on a secondary reaction after a stock has crossed (above) previous
weekly tops and the advance exceeded the greatest rally on the way down from the top."
Explanation - Swing tops 4, 6 and 8 are bear market tops because they are lower than previous
swing tops. Market then goes above swing top 8, falls back making swing top 10, rises to make
swing bottom 11. Swing top 10 is the "Rally" and swing bottom 11 is the secondary reaction.
The advance from bottom 9 to top 10 exceeded the size of rallies 3 to 4, 5 to 6, and 7 to 8. (I
haven't counted 1 to 2).
Entry Point 1 - Buy as market goes above swing top 8, stop under swing bottom 9.
Entry Point 2 - Buy near the bottom of the secondary reaction (11) if you could pick it - it's around
the price of top 8 in this example - (remember "Support and Resistance in Trends").
Entry Point 3 - Buy as the market goes above swing top 10 with a stop under swing bottom 11. That
is, you buy on stop a tick or two above swing top 10 with a sell stop a tick or two below swing
bottom 11. This would actually have been a good buy because a buy just above the top of swing
top 10 with a sell stop under swing bottom 11 would have presented little risk because swing
bottom 11 is close to swing top 10.
Here is what it looks like on a swing chart .Entry Point 3 with its stop, is marked.
Further example
Explanation - National Australia Bank weekly with 2 Bar HotSwing
The Small Bear Market Phase marked turned out to be just a reaction in the longer term bull market
but the formations which follow it are exactly as Gann describes the ideal bull formations.
Entry Point 1 - Buy as market goes above swing top 4, stop under swing bottom 5.
Entry Point 2 - Buy near the bottom of the secondary reaction (7) if you could pick it - it's around the
price of top 4 - (remember "Support and Resistance in Trends").
Entry Point 3 - Buy as the market goes above swing top 6 with a stop under swing bottom 7.
Here's what it looks like on a swing chart
Further example ...Commonwealth Bank Weekly, 2 Bar HotSwing.
This picture shows an Entry Point 1 only.
Here's how the above example of Commonwealth Bank looks on a swing chart ..Entry Point 1 only.
Summary
Gann defines 3 important places for trading in the market. For a Bear Market these are
(1) Sell Point 1 for exiting a long position and initiating a new short position subject to you being
able to define a suitable stop point to limit your risk to a small percentage of your total account size
if the trade goes against you. Gann actually suggests 10% of your account but I would suggest less
than 5%.. We go into more detail on this in future lessons.
(2) Sell Point 2 for initiating a new short position subject to you being able to define a suitable stop
point to limit your risk to a small percentage of your total account size if the trade goes against you.
(This entry point is not actually part of the swing trading method, it is for trading the shorter term,
minor trends).
(3) Sell Point 3 for initiating a new short position subject to you being able to define a suitable stop
point to limit your risk to a small percentage of your total account size if the trade goes against you.
(This entry point is part of the swing trading method).
For a Bull Market these are reversed
(1) Buy Point 1 for exiting a short position and initiating a new long position subject to you being
able to define a suitable stop point to limit your risk to a small percentage of your total account size
if the trade goes against you.
(2) Buy Point 2 for initiating a new long position subject to you being able to define a suitable stop
point to limit your risk to a small percentage of your total account size if the trade goes against you.
(This entry point is not actually part of the swing trading method, it is for trading the shorter term
trends).
(3) Buy Point 3 for initiating a new long position subject to you being able to define a suitable stop
point to limit your risk to a small percentage of your total account size if the trade goes against you.
(This entry point is part of the swing trading method).
Buy Long and Sell Short Points 3 are part of the swing trading method. They are designed to get
you in while both the minor and major trends are running in the same direction and you will often
show an immediate short term profit, a part of which you may care to take.
Carefully study this page a number of times until you memorise the Buy and Sell points 1, 2, and 3,
After you study lesson 6, on how to create the optimal swing charts, you should go through these
rules on a large number of historical swing charts until the formations become second nature. The
creation of the optimal swing charts is a very important step.