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Learning From W. D. Gann – Trend Line Indicator

Many novice traders really like to complicate their trading.

In the beginning, they usually trade on tips from friends or workmates, or something they heard or read in the news.

If they survive the hit they will likely receive to their capital, they may soon come to discover technical analysis as a better way to get a read on price action.

However, often their beginning foray into technical analysis is to lock onto some common charting indicator such as the Stochastic and think they have found the Holy Grail to wealth. Unfortunately that bubble will soon burst when they realize that this and any other indicator only works during certain times and with some adjustment to the parameters.

If this happens to sound like you, and you are still in the game (I know, this is not a game. It’s a figure of speech), then there is hope for you yet. Let me introduce you to W. D. Gann’s “Trend Line Indicator”, which today might be referred to as the Swing Chart.

No matter what market you wish to trade, there are going to be a series of swing bottoms and swing tops that form trends of various degrees. These swing patterns occur on any time-frame, and they are the basic components in determining whether a market is in a bull or bear trend.

The Trend Line Indicator, or Swing Chart comes in several varieties. You can construct a 1-bar, 2-bar or 3-bar swing (I would not bother going beyond this).

The 1-bar swing chart is extremely short-term and is good for fine-tuning an entry. However, for the purpose of determining the trend of any consequence, the 2-bar swing would be my recommendation. In addition, it would not hurt to get the bigger trend picture by constructing a 3-bar swing chart as well.

To construct the 2-bar swing chart is quite simple. Starting from a clearly defined bottom or top, you would draw your swing line (Trend Line Indicator) either up for each new high (starting with the second consecutive higher-high) or down for each new low (starting with the second consecutive lower-low). To demonstrate, let’s start from a clearly defined bottom to draw our 2-bar swing chart line.

With a 2-bar swing chart, we need at least two higher-highs in order to advance our line up to that new high on the chart. So let’s say our starting bar (with the bottom low) is bar #1. The next bar (#2) makes a higher-high but not a lower-low. Our higher-high count is just one, so we do not yet move up our swing (trend) line. Now bar #3 also makes a higher-high and our #1 bar low is still holding. Therefore, we can move our line up to the new high of bar #3.

As each new bar makes a higher-high, we can continue to move our line up to that new high. If a following bar then makes a lower-high and lower-low, our line does not move up and our down count is one. If price resumes the upside move and makes another higher-high than our current highest high (that would be bar #3 in this example), our line would continue up to that new high, and every higher-high until we actually get two lower-lows to change the line direction.

So let’s say that after we’ve been moving our swing line up to each new high that we get a lower-low bar instead. Let’s call this bar #5. If we have been moving the line up to each new high prior to this new lower-low, our lower-low count starts at one. If we get a bar (#6) that makes an even lower-low than the low of bar #5 before another bar makes and even higher-high than bar #4 (which was the last higher-high bar where the line moved up to), our lower-low count becomes two and we would move the line down from the last higher-high (bar #4) down to the low of bar #6. Now for each bar that makes a lower-low than the low where our line is currently sitting (currently bar #6), we would move the line down to that new lower-low.

The bottom-line here (no pun intended) is that we need a count of two higher-highs to start a move up or a count of two lower-lows to start a move down. Once the count has been met, we then could continue in that direction for each bar that exceeds the price where the line is currently sitting.

There are times when a bar makes neither a higher-high or lower-low (called an Inside Bar, or a “within bar” by W. D. Gann). Since they make neither a higher-high or lower-low, do nothing. The line stays put.

There are also times when a bar makes both a higher-high and lower-low (remember that we are comparing each price bar against the previous bar to determine if it is a higher-high or lower-low). This bar is called an Outside Bar. To deal with these bars depends on the currently direction the line has been moving. If the line has been moving to each new higher-high, then you would again advance the line to the new high of this outside bar. On the other hand if the line has been moving down for each new lower-low, you would move the line down to the low of the new lower-low of this outside bar.

The thing to note about Outside bars is that, although you will be advancing your line up or down (depending on the current direction of your line drawing), you must count the opposite side of the Outside bar as a count of one in the opposite direction. Thus, if price then goes the opposite way and exceeds the opposite side of the outside bar, the count becomes two in the opposing direction and the line should then move from the outside (where it is currently sitting) to the bar that made the count of two.

For example, let’s say that we have been moving the line down to each new lower-low (thus the direction is currently down). Then an outside bar forms making both a lower-low (lower than where our line is currently sitting) and a higher-high (higher than previous bar). Since our direction leading up to this outside bar was down, we move our line down to the low of the outside bar (since it is in fact a lower-low). We also want to assign the higher-high of this outside bar with the count of one. Now if the next bar makes a higher-high than our outside bar, the count goes to two and the line moves from the low of the outside bar up to the new higher-high.

After you have done this with your price chart, you will see the peaks that represent the swing tops and bottoms. You will use these peaks to determine the current trend of the market.

For example, a bull trend is a pattern of higher swing bottoms. As long as the market forms each swing bottom peak higher than the last, the bull trend is in effect. On the other hand, the bear trend pattern is made up of lower swing tops and lower swing bottoms. So by nothing where these swing bottoms or tops are forming in relation to the previous one, you immediately can determine the current trend.

W. D. Gann has stated that when the high of a 2-bar swing top has been exceeded, it is an indication of higher prices. He also stated that when the low of a 2-bar swing bottom is taken out, it is an indication of lower prices.

Not only should the trader focus on trading in the direction of the trend, but those swings can also help in determining where to adjust stop-loss orders. For example, if you are long due to the trend being bullish, moving your stop-loss below each higher swing bottom would protect your position in the event a swing bottom low is taken out (as this is an indication of lower prices to come).

Of course these days it can be leaving a lot on the table to use these 2-bar swings for stop-loss orders. Consider this a beginning guideline. One option I may employ is to draw a trend-line under two or more swing bottoms (when long) or across two or more swing tops (when short) and use the slope of that trend-line as a guide for adjusting my stop-loss.

Learning how to identify swing tops and bottoms is a valuable tool for any trader that wants to get a good read on the market. It is mentioned in several lessons by W. D. Gann because it is really that important. In my work, everything revolves around the swings.

Source by Rick Ratchford

Dean Renfro
I help people leverage their time, energy and resources to empower them to create the kind of life they want with a proven, time tested system built on the power of story, the simplicity of sharing, principle of multiplication and the opportunity to leave a legacy for the future.