The 1 Tool I Always Check Before Placing a Trade
WD Gann has arguably contributed more to Technical Analysis, and in particular the understanding of the relationship between Time and Price, than any other trader. It was Gann’s mathematical genius and his ability to see the patterns in the market (that at the time nearly everyone else ignored) that made him so successful and have a legacy that continues to this day.
In developing Market Analyst over the past 13 years, I have had the fortune of learning so much about Gann and the various techniques that can be found in his writings and charts. He researched many areas from geometry to astrology to see what clues they would give him in his search for what the markets were going to do. It is a fascinating area of study and one that I love, but sometimes we can make it too complex and we just need to get back to the basics.
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One of the most basic of the Gann tools is also one of the simplest, the humble Gann Fan. Even with all the squaring techniques that I use in my trading, I still have a couple of Gann Fans on my charts as an overall guide. In this article I will show you the basics of the Gann Fan, how it is constructed, and also how I use the Dynamic Gann Fan to take the whole process one step further.
The Gann Fan is a series of lines that look like a fan radiating out from a major turning point in the market. According to Gann, each of these fan lines give us an indication of possible support and resistance as the market trades near them. Why? I don’t know! Perhaps there are those that can give all the philosophical reasons why this happens, but not me, I haven’t worked it out yet. I’m a Trader and I have seen it work so many times that I know that I know that it does work. For me those lines are like dark clouds leading to rain, those lines won’t definitely lead to a turn in the market, but there is a very good chance they will.
Gann Fan 101
The main concept that we need to understand when using a Gann Fan, is the relationship between time and price that Gann proposed. That is, on average for one unit of time the market will rise by one unit of price. The difficulty comes in defining what one unit of price is. On a Stock that trades in cents, it would be 0.01 because that is the smallest that the stock can trade in. An index like the S&P 500 would have a unit of price of 1, “But hang on!” you may be saying, “The S&P 500 trades in 0.1 increments, why did you choose 1?”. This is where Gann is part science and part art, you need to choose a price unit that “fits” the market that you are looking at. Even when we consider stocks, a stock that trades below $1 needs a different price unit from one that trades near $100, or we’ll just have a series of flat lines.
Now that we have the Price unit sorted out, we can start to draw the lines. The first line is drawn by joining our starting point with the point one unit of time across, and one unit of price up. The following image shows how it is created.
On the Gann Fan we call this line the 1×1 (one by one) or sometimes it is referred to as the 45 degree line, because if you had drawn this on graph paper it would be exactly 45 degrees.
One line does not make a Fan though; the rest of the lines that we need are calculated by taking multiples of the price unit. The 2×1 line is simply one unit of time and 2 units of price etc.
OK, so let’s have a look at some examples.
In this chart of BHP I have placed a Gann Fan at the top of the market which occurred on the 16th May 2008. The red line going down is the 1×1 line, the rest are the multiples of both time and price. In this case I used a Price Unit of 10c, even though the stock trades in 1c increments, to get the scaling just right. As you look at this chart you can see all the times that these lines gave you an idea of where the market was going to turn. It’s not 100%, but it puts the odds in your favor.
I never stop with just one Fan when I am analyzing a market though. The following picture shows the same stock with a second fan added in at the bottom of the market in November 2008.
You can see how again these lines, particularly the 1×2 line, have provided support and resistance to the market. As this market continues to trade I will be watching as it comes near to any of these lines and be searching for a change in trend.
As you can see, the Gann Fan is a powerful tool and one that can be used in conjunction with any other analysis to give you likely points in the market where the trend will change. If you trade in different time frames, you need to be continually choosing which is the best price unit to use. That’s where the Dynamic Gann Fan comes in.
Making it Dynamic
Once you understand what you are looking for with a Gann Fan, it is much easier to use the Dynamic Gann Fan that Market Analyst has to offer. With the Dynamic Gann Fan you need to choose two points in the market. Typically I am looking for the start and end of a major move in the market. The following example is from the SPI (Share Price Index), a futures market in Australia.
I simply selected the start as the low in March 2009 and the top as the recent top in the SPI market at 15th October 2009. The Dynamic Gann Fan draws the 1×1 line between my two selection points and then draws all the other lines (2×1 etc) as ratios from the 1×1 line. When I look at the properties of this tool I can see that it has calculated a Price Unit of 11.471611, now that’s not one of our numbers that we would normally use! In this case we have a Price Unit that this market has used in the past, and we want to see what happens if we use that same price unit in the future.
Below is the same chart with another Dynamic Gann Fan coming down from the top in October 2009. The price unit is the same as the first one that we created. I’ve zoomed in to make it clearer how powerful this tool is.
You can see that in the two months since that top in the market, this Dynamic Gann Fan has been giving us clear signals of where the market is going to turn well in advance. Another extension that is always intriguing is to take the same Price Unit and use it in the Gann Squares or other tools that use a Price Unit.
The Gann Fan and the Dynamic Gann Fan are very simple but powerful tools that you can use in your trading. I now check the fans before I place a trade as I won’t go long just below one of these lines. What I’ve found is that the main thing that people struggle with is the concept of the Price Unit. Once you understand that, you are well on your way to mastering these tools and many of the other Gann tools that use the concept of a Price Unit when squaring Time and Price.