Articles
Trading with Elliott Wave and Gann By David Lamarr
Wave confusion. This is the best way to describe my introduction to the Elliott Wave Principle more than four years ago. I read the books, started keeping an hourly chart updated by hand and had reasonable expectations as to the results of my interpretive skills. Initially, I was able to readily identify bottoms and tops several days after their occurrence and be whipsawed whenever I thought I precisely knew what the wave count was.
I slowly improved my wave count skills to the point that when I identified a particular wave count, it was usually correct. The problem still was determining how to label many of the waves.
Elliott waves provide price targets based on the ratios of .618, .5, .382 and, more recently, .236. These price targets are helpful but difficult to trade with a strong sense of certainty. I discovered the Elliott wave analysis is highly dependent on the individual’s ability to recognize and identify “price patterns.” One strong point of Elliott wave analysis is that it does let you know when you’re wrong—i.e., when a particular retracement is penetrated look for support at the next retracement level.
Intellectually, it’s relatively easy to develop a trading strategy. If a .382 retracement appears to halt downward price movement, then buy. If this level is penetrated, exit the position quickly. Repeat the process with a .5 retracement. If necessary, repeat with a .618 retracement. The two losses will be small and the third trade should provide good profits that more than cover the first two losses. Emotionally, though, I feel this is unworkable for the majority of traders, including myself.
Gann and Elliott
Using Gann lines helped me tremendously in determining likely support or resistance levels. Almost without exception, a Gann line from a significant bottom or top will intersect an Elliott retracement level. A position can be entered at this point with a reasonable degree of certainty as to when to exit.
I decided to try Gann lines on the Dow Jones Industrial Average (DJIA) hourly chart. From past experience, I knew Gann lines were only moderately effective on the DJIA daily chart because, although it provides the actual close, the high and low for the day are fictitious. Before the days of computers, the exchange calculated the high and low for the day by assuming all the DJIA stocks made their high and low at the same time! This is understandable, but any projection based on the daily highs or lows is untradeable. The hourly data, however, is based on the actual hourly level of the DJIA, so strategies based on these values are tradable.
Drawing Gann lines on an hourly chart is almost impossible, at least for me. I used 8.5-by-1l-inch chart paper with a one-point-per-hour scale. After several months, my chart was 8 feet long and growing rapidly at a 45-degree angle. After a year, the chart could only be fully extended on the floor. Drawing Gann lines from an obvious top or bottom would work for a week. After a week, the price action consistently moved away from the Gann line. If I wanted to follow the line, I had to add graph paper in the direction of the Gann line and paper in the direction of the price action. I was papering the office wall to keep track of everything!
Data compression
I tried changing the price scale to reduce the daily fluctuations. I kept three hourly charts of the DJIA and chanced on a remarkable observation. As I reduced the daily fluctuation, the Elliott wave count became clearer. By compressing the hourly data, I could reveal longer-term waves. On the most compressed chart, intermediate waves became apparent. Another chart revealed minor waves and the massive, uncompressed hourly chart contained all the minute wave details. This was a way to filter Elliott waves in order to “see” the different wave magnitudes!
Now I only had to keep and update three or four charts on every item I followed. However, even on the compressed charts the different Gann lines would often run off the page. There had to be a better way! I searched high and low for software that would graph hourly data and draw Gann lines. In the end, I wrote a program that allowed me to manipulate and filter Elliott waves as I did by hand and draw Gann lines from any point.
Technique
After the hourly data was entered in the program, I first looked at the last significant low. Figure 1 displays the longer-term Elliott waves. Labeling these waves is relatively easy and Gann lines can be drawn from obvious tops and bottoms to determine significant support and resistance. One point: a 1×1 or 45-degree Gann line may not “look” like a 45-degree angle on this chart because the program scales the Gann line based on the amount of data and total number of days displayed.
FIGURE 1
At the end of August 1987, my wave count indicated the fifth wave of Intermediate Wave 3 had been completed in mid June. That meant the market was entering a multi-week, possibly multi-month Intermediate Wave 4 correction. In either case, initial support was at the 2×l Gann line drawn from the May 20 bottom at 2205 to 2465 on August 27, and increasing one point per hour.
This interpretation fit very nicely with the Elliott wave retracement levels. From the hourly low on May 20 to the top at 2732 was 527 points. The retracements were: 38.2% = 2530, 50% = 2468 and 61.8% = 2406. Note how the Elliott 50% retracement level at 2468 coincides with the Gann line support. At that point, a countertrend rally would be expected.
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As all experienced Elliott wave technicians know, there may be several valid wave interpretations for a particular move. I’ve labeled the completion of the fifth wave of Intermediate Wave 5 just before the high at 2732. An alternate count would be to make the high at 2732 the top of this fifth wave. In either case, the wave structure would still call for a decline.
As a rule, the longer a Gann line is in force without being violated, the stronger the support or resistance will be.
Next, I graphed the last 40 days of hourly data (Figure 2) to obtain the shorter-term wave count starting at the end of Intermediate Wave 4 and drew Gann lines. Intermediate Wave 5 was subdivided into five waves (points 1 through 5) which could be counted as already being completed and followed by a correction in progress. Corrective waves A and B were already completed and C was in the works.
FIGURE 2
Note how the decline stayed above the declining 1 × 4 Gann line from the top at 2732. Although the decline came into minor Gann line support at the 2660 level, more significant support was at the 2640 area where multiple lines met.
As a rule, the longer a Gann line is in force without being violated, the stronger the support or resistance will be. Likewise, the intersection of multiple Gann lines provide probable turning points, in part, based on the strength of the Gann lines.
Finally, I repeated the process for the last 10 days (Figure 3) to see the minute waves and the makeup of the corrective waves. A minute wave correction was under way with both waves A and B completed and C in progress. I expected support at the 2639 level, which coincided with the bottom of minutewave 4 and was the approximate level at which multiple Gann lines provided support.
FIGURE 3
Although I believe I have an accurate projection of probable market action with Elliott and Gann techniques, I consult other analysis tools and enter positions based on a preponderance of the available evidence. In this case, time cycles also pointed to a minor low on August 31 and stochastics indicated an oversold market. So I was expecting a countertrend rally even though the overall trend was still down and in a corrective mode.
FIGURE 4
Figure 4 shows the market action after I conducted my analysis on August 27,1987. The DJIA index rallied from the 2639 hourly low on August 28 to the 2684 hourly high, before declining on September 1, 1987. OEX rallied approximately five points during this period. Of course, trading against the predominant trend such as on a countertrend rally requires extreme caution since the rally probably will end abruptly and quickly fall to lower levels. But it is just one example of how the power of Elliott and Gann can be combined to enhance each other and provide accurate entry/exit levels.
David Lamarr is editor of the WINNING STRATEGIES investment newsletter specializing in Elliott wave and Gann market analysis. In late 1987, he was in third place in the United States Investing Championships, options division, 4Q87, with a 129.8% ROI.