price action can hardly be determinative of the market’s trend. You are in for a surprise.26
Gann Swing Charts
Change of trend and intermediate swingsThe main use of a Gann swing chart is to identify and trade a change in trend. But Gann madeit clear that the swing chart can also be used for trading the intermediate swings.Look at the Reuters chart below, covering the period June 2000 to February 2001. It is clear thatthere is a broad uptrend until early September 2000, followed by a broad downtrend. Within theuptrend there are several good buying opportunities, when Reuters makes swing lows at pointsA, B and C. Likewise, during the downtrend, there are several good selling opportunities whenReuters makes swing highs at points D, E, F and G. It’s the capture of these opportunities whichinspires me.
D
EF
C
G
BA
fig 3.3What the swing chartist/swing trader attempts to do is to trade either the whole of the broaduptrend/downtrend or sections of it by trading the swing highs/lows, or both.
27
Marc Rivalland on Swing Trading
Construction of a Gann swing chartI deal with this only briefly because my modifications do not actually require the swing chart tobe drawn.A swing chart is a line superimposed on a bar chart highlighting the swing highs and swing lows.As prices go up, one draws a line connecting the daily highs of the share price. Inside days(lower high, higher low) are ignored. Down days are ignored until, according to Gann, threeconsecutive down days occur. At that point, the line swings to the bottom of the third bar, andis connected to each lower low made by the bar chart. Again inside days are ignored, as are updays until there are three consecutive days up.The result looks like an irregular wave pattern (fig 3.4), although it is often drawn in the formof a Manhattan chart (fig 3.5).
fig 3.4
28
Gann Swing Charts
fig 3.4
fig 3.5That all sounds simple enough. One can get very excited when looking at the Gann swing chart.The clear pattern of rising lows makes it look as if there is easy money to be made, and indeedit does portray the short-term trend very well. However when it comes to applying the chart fortrading purposes, it seems to me to have a number of serious drawbacks, so I have made anumber of modifications, which I explain in detail in the next chapter.With any swing chart, an uptrend will be characterised by successively higher swing lows and,in the main, higher swing highs. In a downtrend, there will be successively lower swing highs,and, in the main, lower swing lows. There are two central tenets of a Gann swing chart:1. The trend changes from up to down when and only when a previous swing lowformed during the uptrend is breached.Closing prices are irrelevant. When the lowest point of the last bull market market swing low29
Marc Rivalland on Swing Trading
is breached on any day thereafter, it is a sell signal - a new downtrend has commenced. Viceversa for a change in trend from down to up. See point C on fig 3.1 and fig 3.2 in this chapter.I make no modification to this principle.2. Thereafter, each time the market makes a new and lower swing high and thendeclines to fresh lows, the downtrend is re-affirmed, and for aggressive traders, a freshsell signal is given.I have modified this principle to try to capitalise earlier on the fresh sell signal.Gann swing charts have a distinctly mechanical flavour to them. Indeed Gann called his method‘The Mechanical Method & Trend Indicator’. It is a deliberate attempt to impose a rule-basedsystem on the market. This is an excellent idea, because it leaves less room for the foibles ofindividual traders to intrude. But whereas some rule-based systems are weak on logic, andappear to work only because empirically they can be shown to have worked in the past, swingcharts have considerable logic underpinning them. They delineate exactly where supply anddemand dominated the market on previous occasions. Insofar as that is an inadequate guide tothe future, it is a fault common to all charts. Moreover the swing chart fits very well the rhythmof the market which everyone can see unfolds in swings of various lengths and amplitudes.In my opinion, provided one is dealing with high volatility stocks or equity indices, the swingchart is by far the best chart available to traders. I understand that many accomplished swingtraders will already be using their own favourite chart. But most swing traders will not have triedseriously to harness the power of swing charts. I assure you it is worth the effort.In any event, you can use swing charts in conjunction with your own favourite chart. I use twodifferent types of chart. Since I am a top down type, and the first question I ask before makingany trading decision is, ‘what is the trend of the market?’, it follows that my first and mostimportant port of call is my swing chart of the market. But as you will see, swing charts onindividual equities have more variable results so I use a combination of swing charts and point& figure charts and, as regards individual equities, the point & figure charts have the final say.
30
4
MODIFIED SWING CHARTS• Definitions• Faults with the Gann swing chart• Modification 1 - ‘Get in Early’• Modification 2 - ‘If the third day is an outsideday, it is part of the correction’• Modification 3 - ‘Relax the requirement forthree consecutive days’• Modification 4 - ‘Count trading days only’• Buy and sell signals• Change of trend signals• Continuation of trend signals• Problem areas• Tailpiece
31
Marc Rivalland on Swing Trading
DefinitionsAs I’ve said, at heart I am a market timer. Timing the broad and the lesser swings of the marketas a whole is what motivates me.I never fail to look at the message conveyed by my point & figure charts, but for timing themarket as a whole and for trading index futures and options, my swing charts dominate. You,the reader, could go further. It is entirely possible to time the markets, and to trade index futuresand options by using swing charts only. If you don’t like point & figure, so be it. The swing chartis a winner all by itself.The modifications I have made to Gann’s swing charting theory represent my attempt to makethe swing charts as effective as possible from a trader’s perspective and to enhance my timingof the market.As I’ve mentioned, my modifications mean that you don’t actually have to draw a swing chart.Interpretation and trading can be done from an ordinary bar chart.It is the highs and lows recorded by the bar chart which are important. In this chapter, when Irefer to an ‘up day’ I mean a day with a higher high and a higher low than the previous day. Theclosing price is not relevant to this definition, although of course in general terms the close isan important tool from which useful inferences may be drawn. Likewise a ‘down day’ is a daywith a lower high and a lower low. Inside days (lower high, higher low) are generally ignored.Outside days (higher high, lower low), which do represent significant price action, receivevariable treatment (explained in the glossary).
Faults with the Gann swing chartThe principal focus of a Gann swing chart, and of my modified swing charts, is the identificationof relevant countertrend rallies/dips. They form a reference point both for trading and fordetermining the trend.Gann regarded a one day rally in a downtrend as irrelevant, however substantial the rally. Whathis method seeks to do is to focus on those corrections in a short-term trend which portray animportant level where supply exceeded demand or vice versa. The problem is how to define theimportant, and exclude the unimportant in a way which allows for as little subjective opinion aspossible.In a downtrend, the standard Gann swing chart turns up and registers a countertrend rally, aswing high, only when there are 3 consecutive days of higher highs. I regard that as a bit of afault. But much, much worse is the notion that the countertrend rally is over and the maindowntrend has resumed only when there are a further 3 consecutive days down. The standardGann chart gives one a very good idea of direction, but the stipulation that the main downtrend32
Modified Swing Charts
has resumed only if there are 3 consecutive days down is not only unwieldy for traders, it iscounterintuitive.It is obvious, on a glance at the past history of any chart in a downtrend (uptrend), thatthe main trend has resumed as soon as the countertrend rally (dip), the correction, is over.Of course, the tricky bit is to determine in real time exactly when that has happened. I do notbelieve that task is aided by the inflexible requirement that the main trend resumes only whenthere are 3 consecutive down days after the countertrend rally. Take for example the FTSE inMay 1999.
Swing High
1
Sell
2
fig 4.11.
The market made a swing high on 24th May. It is obvious (with hindsight) from the chartthat the correction, the countertrend rally, ended after the high was made that day, but -
2.
The standard Gann swing chart would signal that the main trend had resumed only on thethird day down, by which time most of the move was already over, and it would give a(repeat) sell signal only on the breach of the previous swing low which happened on thefourth day down, the 28th May which was the very day the downswing ended.
33
Marc Rivalland on Swing Trading
My modifications mean that you would be able to act as if the main trend had resumed on theexact day that it did in fact resume, the 24th May.Shortly before he died, Gann wrote in longhand, across his typed notes about trading grains, thata 2 day swing chart was more useful. Whether he meant that generally or in respect of grainsonly is not clear. In other words, instead of insisting on 3 consecutive days down (or up), Gannwas apparently suggesting that 2 consecutive days were sufficient. But even a 2 day swing chartwould have turned down only on 26th May, by which time the market had fallen substantiallyfrom its actual swing high.A further huge drawback of Gann’s swing chart theory is the notion that a repeat sell signal isgiven only when the last swing low is breached. Of course, breaching the previous swing low isindeed important confirmation that the downtrend is continuing, and if it were practical to waitthat long before selling short in a downtrend or buying in an uptrend, I would be delighted to doso. But the stop loss involved would be crippling (at any rate for a trader with my risk profile).Look at fig 4.1 above. Standard Gann practice (when pyramiding, as he called trading theintermediate swings) is to sell short at 6146 when the swing low is breached and place the stoploss above the swing high established on 24th May, namely at 6463. That’s a stop loss of 317 points.Even if one bent the rules slightly and sold short on the day that the standard Gann swing chartsignalled a resumption of the main trend, the stop loss required would be so large as to make therisk/reward ratio hopelessly unattractive. A standard 3 day swing chart would have turned downon 27th May, so the stop loss required would be 263 points if you sold on the close. A standard2 day swing chart would have turned down the day before but the stop loss required would bestill be 227 points. These stop losses would be ruinous. As you will see in due course, the profitfrom each successful intermediate swing trade in the FTSE typically falls in the bracket of 150400 points, although profits are occasionally larger, particularly in linear phases.I wouldn’t dream of risking over 200 points on a FTSE trade. Sometimes I forgo a tradeif the potential stop loss is too large. There can’t be more than a couple of occasions in mylife when I’ve risked over 150 points on a FTSE trade.Using my modifications a short position would have been established on 24th May at 6344, animprovement of 144 points (at least) on the 3 day swing chart and 107 points on the 2 day chart.Whilst I’d prefer my stop loss in FTSE to be under 100 points, that is not always possible. Withmy modifications, the stop loss here would have been 119 points which is high-ish but acceptable.Even without pyramiding (trading the intermediate swings), you will find that the standard Gannswing chart looks superb and is occasionally superb to trade, but often produces steep losses,which negate much of the worth of the chart. That’s why I’ve made modifications. Not everyonewill agree with my modifications to Gann swing chart theory, but here they are.
34
Modified Swing Charts
Modification 1 - ‘Get in Early’Like Gann, I look for a 3+ day movement to identify a countertrend swing, but I trade withthe trend on the first day after the countertrend swing appears to end. In short, I use a 3day swing chart to set up the trade and a 1 day swing chart to activate the trade. One couldcall it a 3 bar/1bar swing chart. Effectively I am assuming that after the market has a 3+ dayrally in a bear market (or a 3 day decline in a bull market), the first day that the market revertsto trend means that a swing high (low) has been established. This may sound complicated, butit is not. It is simplicity itself. It is merely complicated to describe. Look at the FTSE chart for8th March 2001.
4 Day Rally
2
Sell
1
fig 4.2
The market was plainly in a downtrend, having crashed in February through the January lows.The swing trader is looking for a countertrend rally to add to a short position or to initiate one.
35
Marc Rivalland on Swing Trading
1.
The decline ends on 2nd March and there is a 3 day rally on 5th, 6th and 7th March. From7th March onwards, I am looking to sell the market on the first breach of a previous day’slow i.e. I’m looking for the first down day after a countertrend rally of at least 3 days. On8th March I place a stop sell order underneath the lows of 7th March. But nothinghappens, because on 8th March, the market makes a higher high and a higher low. It isthe fourth up day of this countertrend rally.
2.
On 9th March, again I place a stop sell order this time below the lows of 8th March, andlater in the day on 9th March, the previous day’s low at 5981 is breached and my stop sellorder is triggered. I am now short. I place a protective stop loss above the assumed swinghigh (the high of 8th March) at 6051.
It works perfectly. The market falls 500 points in 4 days. Have I chosen a good example toimpress you? Of course! But I won’t be shirking the trickier situations. I’ll deal with them as Igo along.Once again a 2 day and 3 day standard Gann chart would have got one short, this timesuccessfully, at much worse levels, and the size of the potential stop loss would have been a bigdeterrent.
Modification 2 - ‘If the third day is an outside day, itis part of the correction’This modification deals with outside days. Please see the glossary for a fuller treatment ofoutside days. At this point, I am dealing with how to treat the third (and potentially crucial) dayin a countertrend rally if it doesn’t have a nice, simple higher high and higher low. What happensif it has a higher high but a lower low? Does that count as part of the rally or not?• If the market has a 2 day rally and on the third day it makes a higher high, I regard thatas an upturn in the swing chart, even if it later makes a lower low on that third day. Manyswing chartists follow this principle, but not all do so which is why I’ve classified it as amodification.• As soon as the market has made the higher high on the third day, I place a stop order tosell below the low of the second day.Look at fig 4.3, the FTSE chart for 28th January 2000.
36
Modified Swing Charts
Outside day
Sell
fig 4.3The market rallied on 26th and 27th January and opened up on 28th January making a thirdconsecutive higher high. Place a stop sell order below the low of 27th January, and later on 28thJanuary, the stop is hit and a short position is established. This is not too large a modification.Effectively one is trading an outside day which in standard bar charting terms is indeed regardedas bearish. This modification also explains the short position established on 24th May 1999 inthe first chart in this chapter.Naturally the same principles hold true in an uptrend, when the third day of a countertrend dipis an outside day, and the market, having first moved lower, later takes out the highs of theprevious day.
37
Marc Rivalland on Swing Trading
Modification 3 - ‘Relax the requirement for threeconsecutive days’If you wait for a perfect 3 consecutive days up or down, you may end up feeling a bit likeVladimir and Estragon3. What was Gann trying to say when he insisted on 3 consecutive daysup? It seems to me one can fairly conclude that Gann was saying that a one day rally, howeverstrong, is unimportant. The same is true of two consecutive days up or down (although late inlife, Gann apparently recanted, at least in part, on this point).But you will often find that the market is not quite so accommodating as to go up and down inconsecutive three day spans. Can it really have been that important for the swing chart to turnup only when the up days are consecutive? It seems to me that this is the over-rigid applicationof mechanical rules. Surely Gann was saying that to be significant, a corrective rally or a dip had tolast at least three days. If the market goes down on two consecutive days and then up on the thirdday but then falls again on the fourth day, that seems to me to be a valid swing low in the making.
AB(i)
(ii)fig 4.4
Look at (i) and (ii). Assume the trend is up. The standard 3 day countertrend pullback is shownin (i). A swing low is established at point A. According to Gann, point B in (ii) does not qualifyas a swing low, because the down days are not consecutive. I suggest there is no substantive3. Waiting for Godot by Samuel Beckett
38
Modified Swing Charts
difference between (i) and (ii) when it comes to defining a swing low. And it is important to beclear about what is and what is not a swing low, because it represents the trend change point. Soin (i) and (ii) above, if the market should later fall through points A and B, Gann would see achange in trend in (i) but no change in trend in (ii). That cannot be right. Look at the FTSE chartfor August 1998:
Swing High
4
Sell
2
31
fig 4.51.
A low is made on 13th August 1998 at 5350.
2.
The next day Friday 14th August is an up day.
3.
The 17th is a down day because both the high and low (at 5398, 2 points lower than theprevious low of 5400) are lower than on the 13th.
4.
The next 2 days are up days. It seems to me that a valid swing high has been created.39
Marc Rivalland on Swing Trading
You don’t need a rule that the up/down days have to be consecutive. It meets the heart of theprinciple employed in swing charting to permit more haphazard rallies to be counted as part ofa swing high. I don’t regard a one day interruption to the span of up days or down days assignificant. That is easy to apply. The situation is more tricky when more than one day interruptsthe countertrend 3 day rally/dip.Complex swing highs and lows
Look at any bar chart and you will see that sometimes the swing high or low is a rather complexaffair. What I look for is a total of 3 days up or down, whether or not they are consecutive,provided they occur in a relatively short space of time. In other words I disregard the fact thatthere may have been even 2 days or more interrupting the correction. Look at the chart forBarclays in October 2001.
14
8
352
6
Buy
7ComplexSwing Low
fig 4.640
Modified Swing Charts
1.
Barclays makes a high of 2144p on 11th October.
2.
The next 2 days (12th and 15th October) are down days.
3.
16th October is an inside day. Ignore.
4.
17th October is an up day. Perhaps Barclays is not going to make a swing low at thispoint.
5.
18th October is an inside day. Ignore. Already 5 days have elapsed since the swing high,but I regard only 2 of them as relevant. I haven’t yet given up hope that this market maybe in the course of forming a relevant swing low.
6.
19th October is a down day.
7.
Monday 22nd October is also a down day, helpfully with a low below the low of 15thOctober. I am also encouraged by the fact that the range for the day i.e. the differencebetween the high and the low is narrow, suggesting no real selling pressure.
8.
23rd October, buy when Barclays breaches the high of 22nd October (2023p). Place astop loss below the low of 22nd October (1974p), on the assumption that that pointrepresents the swing low.
The assumption is borne out as 1974p is not breached and Barclays trades up to over 2300p byearly January.Note that the up day on 17th October must not exceed the swing high of 2144p. If it does, a newswing high will have been created and I will wait for a new 3 day retracement.Deciding whether or not the low of 22nd October should be characterised as a swing low is nomere academic debate. The whole basis of trading with swing charts depends upon identifyingswing lows (or highs), the later breach of which is regarded as significant. So for example in theabove case of Barclays, if the price had fallen after 24th October, my modification would meanthat a stop loss would be activated at 1974p, and crucially that the trend would be regarded ashaving changed from up to down at that point. A short position could then be established at thatpoint. The standard Gann swing chart would not call a change in trend even if Barclays wentdown as low as 1500p (because no consecutive 3 day swing low had been breached). Look atthe above chart. How is it sensible to regard Barclays as still in an uptrend if it had fallen after24th October to the 1500p level?Purists will say that the identification of this kind of complex swing low is no longer entirelymechanical. An element of judgment has crept in. I agree. I think the swing chart is all the betterfor this modification. Mechanical rules need to yield to common sense sometimes.An example of a share not making a complex swing high is Marconi in January 2001.
41
Marc Rivalland on Swing Trading
Sell
524
31
fig 4.71.
On 3rd January Marconi makes a low at 634p in the course of its downtrend. That eveningMr Greenspan makes a surprisingly aggressive inter-meeting cut in interest rates, which
2.
produces a prodigious rally the next day as Marconi touches 740p.
3.
The next 5 trading days are messy. There are 2 down days followed by one up dayfollowed by 2 down days. I don’t draw any firm conclusions, but so far this doesn’t lookmuch like a swing high in the course of forming.
4.
12th and 15th January are up days.
Note: I do not count this as a 3 day rally for 2 reasons. First, there are a lot of days betweenthe first up day and the third day. This is not conclusive, but I am not convinced this is allpart of the same rally. It may be, but why take the risk? Secondly, and more importantly, theputative swing high on 15th January is well below the high of the first up day (4th January).42
Modified Swing Charts
If I sell short which of the two is the swing high? Where do I place my stop loss? Too manyimponderables. Don’t touch this stock when it trades lower on 16th January.5.
On 17th January 2001 Marconi storms higher, exceeding the 4th January high of 740p.Now there is a decent 3 day rally, and one can prepare to go short. A prior day’s lowis breached on 22nd January and a short position can be established below 769p.Marconi never sees this level again and never will.
At this point in the book, we are looking at matters only from the perspective of swing charts.In fact, as I’ve already pointed out, I also use point & figure charts. I did not short and wouldnot have shorted Marconi on 22nd January 2001 (more’s the pity!) because the point & figurechart had taken on an attractive aspect. I would have been in two minds what to do, and I wouldtherefore have chosen something easier.Combinations
An example of a complex swing high combined with an outside day was provided in January2000. The much-hyped Y2K fears turned out to be largely groundless. In the first 3 trading daysof the year the market crashed through the swing lows made in December and so one waslooking for an opportunity to add to or to initiate a short position.
5
24
6Sell
1
3
fig 4.843
Marc Rivalland on Swing Trading
The low is made on 6th January.1.
7th January is an inside day. Ignore.
2.
10th January and 11th January are up days.
3.
12th January is a down day.
4.
13th January is an up day but its high is well short of the high of the second up day, soI’m not ready to sell. Optimally the high on the third day should be higher than the dayyou are counting as the second up day, but if it is nearly the same, I will count it as thethird day up because I will have a clear place to put a stop loss.
5.
The 14th January makes a new high for the rally. Now I’m ready to sell on the first breachof a prior day’s low, on the assumption that the high already made will turn out to be theswing high.
6.
In fact, the market completes another up day on 17th January, so even a standard Gannswing chart would have turned up at this point. The narrow daily range encourages me.It is suggestive of no real buying pressure. On 18th January my stop sell order is belowthe low of the 17th at 6637. The market trades up initially, and then collapses, triggeringmy stop sell order on an outside day.
Note once again that my modification means that the short position is established early.Compare a 2 bar swing chart and you see that it would have turned down only on the 19th,and a sell signal on a 2 day or 3 day swing chart would have happened only on a breach ofthe lows of 6th January at 6423, requiring one to risk 273 points by placing a stop loss abovethe 18th January highs at 6696.It is impossible to list here all of the possible variations which a bar chart might throw up todetermine whether a market has made or is still making a complex swing low or high. In essenceI am trying to import the spirit of some of the mechanical rules applied by Gann, whilst stillleaving open the use of some judgment. If you’re not sure whether the market has made a swinglow/high, back off. Wait for it to prove it to your satisfaction. If that means missing a good trade,so be it. There are many good trades waiting for you in the future.
Modification 4 - ‘Count trading days only’Some people who use Gann swing charts count Saturday and Sunday as a part of Friday’strading. It follows that every time there is a one day countertrend move on a Friday, the 3 dayswing chart turns up or down. I fail to see the sense in this. I could be persuaded that Fridayought to carry more weight than any other day of the week, but not 3 times the weight. I countonly trading days, not weekends.Final Thoughts on my Gann modifications
There is an obvious tension between the reliability of a signal, and the desire to establish a44
Modified Swing Charts
position early so that the risk/reward ratio is favourable. As will be seen, my modifications dohave some disadvantages but the balance I have struck suits my risk profile, and, I suggest, therisk profile of most swing traders.
Buy and sell signalsThere are two types of buy/sell signal given by the swing chart. The first is a change of trendsignal, and the second is a continuation of trend signal after a countertrend rally/dip hasended. Gann was interested primarily in change of trend signals, but you miss too much if youignore the continuation of trend signals.
Change of trend signalsWhenever a security which has been in an uptrend, falls and breaches a previous swing low,there is a deemed change of trend. A new downtrend is established. A change to a new uptrendoccurs whenever a market, which has been in a downtrend, rallies above a previous swing high.Consider the chart for HSBC in late 2000/early 2001.
E
Change ofTrend
D
CA
B
fig 4.945
Marc Rivalland on Swing Trading
After a series of higher swing lows at 926p on 30th November 2000 (point A), at 934p on 15thDecember 2000 (point B) and at 971p at 11 January 2001 (point C) and finally at 1033p on 5thFebruary 2001 (point D), HSBC staggers upwards to 1075p, but cannot attain the levels of theJanuary swing highs. Twelve trading days later, it crashes through the swing low of 5th February2001. That is the signal that the trend has changed from up to down. A short position should beestablished when 1033p is breached.Note how the lower high at 1075 (point E), followed by the lower low of 21st February is aclassic microcosm of Dow theory.• At the swing low of 1033p (point D), the market consensus was that prices were cheap.From that point onwards, buyers dominated sellers, driving prices up. When that samelow at 1033p was breached 12 days later, it is an obvious inference that the marketconsensus had altered. What was formerly considered too cheap at that level had becometoo expensive as sellers dominated buyers.I hear the sceptics say suppose the market just bobs a little way below the first swing low andstorms upwards again. Well that does happen sometimes. But as I’ve already pointed out, thechartist knows that market price action evolves over time. He assumes that there is probably agood reason for the breach of the previous swing low, and that it will take time for a newconsensus to emerge. That assumption is often borne out, but plainly not invariably so.• How far below 1033p should the short position be opened? Gann’s view was that abreach by a single tick was enough, although the tick size when he was trading waseighths of a dollar. Modern Gann chartists adhere to the belief that a breach by a singletick is sufficient to constitute a buy/sell signal. I do follow this as