1.1 - Why is Buying Low & Selling High So Elusive?
The objective is simple and seems so easy to achieve - - buy low and sell high, or sell high and buy low. But the ability to do this is quite elusive. What is high and what is low?
The methods used by W.D. Gann are unique in quantifying the answer to these questions and are based upon the long-term price history in a market. He derived his definitions for what is overbought and oversold based upon the actual moves which have taken place in the past. At first blush, this may not seem like an earthshaking revelation. But when you consider the infrequency with which investors, traders and analysts look back beyond 10 years, let alone 60 years, the distinctiveness of Gann's forecasting methods is brought into the light.
To provide a foundation for why his analysis is so profound, we must first understand the basis for why it works. Once we do this, you will understand why the methods discussed in the lessons concerning time periods, the Master Time Factor , price formations and value relationships are so powerful.
1.2 - The Challenge to Us as Investor's and Speculators
The first challenge for the investor or speculator is quantifying what is low and what is high. The second is having the emotional makeup to buy on weakness when everything looks grim and sell on strength when everything looks rosy.
When the legendary Green Bay Packers coach Vince Lombardi gathered his professional football players in the first pre-season meeting, he started his instruction by saying, "This is a football." Indulge me while I do the same by making this statement: "The place to buy for the greatest return possible is at the bottom of a bear market after the trend has turned up and at the bottom of periodic major corrections during a bull market." The reverse is true when selling short: "The place to sell for the greatest return possible is at the top of a bull market after the trend has turned down and at the top of periodic major corrections during a bear market."
1.3 - 1st Principle: Human "Weakness" at the Center of Market Movements
In order to solve the mystery to unlocking the markets' riches, there are two foundational principles that relate to people.
The first principle is this: When it comes to money, 98% of people are driven by the three controlling emotions of hope, desire (greed) and fear. To succeed in speculation, not only do these emotions need to be controlled, but the investor or trader must learn to do the opposite of what his instincts tell him or her to do based upon these emotions.
When a market is declining and marketplace participants ("the crowd") are fearful, the successful speculator must be able to steel his emotions and look to buy based upon hope. When a market is advancing, and the crowd hopes for a much greater advance, the successful speculator must steel his emotions and fear the possibility of losing hard-earned profits based upon the likelihood of an imminent top.
The twin demons of desire (greed) and fear ask questions like these:
- "Do you realize what you can get (freedom, wealth, power, fame) if the market continues to move in your favor and you make such and such an amount of money?"
- "Do you realize what you stand to lose (freedom, wealth, power, fame) if the market continues to move against you and you keep losing money?"
In the first, the trader throws caution to the winds without regard to risk and ends up overtrading. This is the biggest mistake one can make in the market. In the second, the trader panics out, invariably at the wrong time. When market decisions are made on the basis of these two driving emotions, the tendency is for the trader or investor to buy the highs and sell the lows - decisions based on feelings rather than facts.
1.4 - 2nd Principle: Trading Opposite the Crowd at Strategic Turning Points
The second principle is the real key to understanding why you can be successful. Since the vast majority of market participants are motivated by the same three emotions, they tend to do the same things at the same time in the marketplace. As a result, they demonstrate a herd mentality and move in and out of a market as a "crowd." Their collective optimism carries prices to overbought levels and their collective pessimism carries prices to oversold levels. Quantifying the extent to which the crowd will do this in a given market situation is where W.D. Gann's analysis comes to life. By defining the degree to which culmination points have carried prices historically, we can harness wealth-building moves like at no other time in history.
The old Wall Street maxim states, "Buy on rumor, sell on fact." In general, we must sell when good news comes out and buy when bad news is out. The market almost always discounts the news in advance, except when it is sudden and unexpected.
he extremes of optimism and pessimism are described in the classic volume, Extraordinary Popular Delusions and the Madness of Crowds. The madness occurs anytime the thoughtful reasoning of the individual is replaced by the unthinking crowd. In the markets, when these emotional extremes occur, opportunity is at its greatest. Such emotional extremes coincide with great culmination moves followed by dramatic turning points.
1.5 - What Gann Said about Human Nature
W.D. Gann put it this way, "If you will only study the weakness of human nature and see what fools these mortals be you will find it easy to make profits by understanding the weakness of human nature and going against the public and doing opposite of what other people do.
"Human nature never changes and that is why prices swing from the one extreme level to the other. People get too hopeful and optimistic when prices are high. Then when prices reach extreme low, they get too blue, too pessimistic and over-sell."
In the arena of investing and speculation, reality is literally turned upside down. One of the great character qualities that have made the United States so great is hope. The entrepreneurial spirit maintains hope and resolve in the face of seemingly insurmountable adversity and challenges. This indomitable spirit is the engine behind innovation. Unfortunately, this same character quality is disastrous in the arena of investing and speculation. Holding doggedly to one's opinion in the markets is one of the greatest causes of losses on Wall Street. The markets demand submission and flexibility.
1.6 - Generations Can Elapse before History Repeats
The old saying that "Those who don't learn from history are doomed to repeat it" applies notably to the area of speculation. By observing and comparing past market movements to our current markets, we can determine what prices will do in the future because the future is a repetition of the past. Price moves always tell a story similar to previous chapters in history. By learning the history of a commodity and the cycles that dominate its trade, we can then cash in on the probability that similar conditions in the past will produce similar results in the future. The more time spent studying history, the greater one's confidence becomes.
After many years of applying this great market truth, it amazes me that so few take the time to consult history for the answers it gives. Commodity price data is not even available from any charting or data services before 1960. Having 44 years of data may seem like a long period of time, but in the context of history it offers very limited perspective. Cotton futures started trading in 1867; corn, wheat and oat futures started trading in 1877. Coffee, sugar and cocoa began trading in 1881, 1916 and 1926, respectively. Cash prices, while hard to find, are available in almost every commodity for the past 200 years. The reason prices are unavailable is because there is so little demand.
1.7 - Commodity Prices since 1760
A look at the history of overall commodity prices since 1760 will show the importance of having a long-term historical basis for market forecasts. In Figure 1.7, you can see that history is marked by alternating periods of inflation, deflation and price stagnation. As you can see, there have been six major inflationary bull markets, which carried prices into final highs in June 1781, December 1814, August 1864, May 1920, February 1951 and November 1980. The deflationary periods following these respective highs lasted 11, 29, 32, 13, 17 and 19 years.
If a trader made market decisions in the 1980s based upon the assumption that the 1960s and 1970s brand of inflation would continue, major losses would have resulted during the 19 deflationary years between 1980 and 1999. However, by knowing that the minimum deflationary declines between 1781 and 1792, and 1920 and 1933 were approximately 12 years, the speculator would have anticipated the likelihood for a historic deflation. Do you see why a multi-generational perspective is so important and how the rules of the game are changed?
This leads us to our next principle, that we can never have enough historic data to work from. The more data we have, the better our vision. The better our hindsight based upon history, the greater is our probability for success. As Gann said, "you cannot have too much information or too many records when you are going to risk your capital."
Figure 1.7
1.8 - Our Memories are Short
Gann stressed another quality about human beings, which we need to appreciate. Our memories are short. It is difficult to remember the past. When you look at the history of markets over a 100-year period, it becomes clear that price eruptions take place periodically in every market and by definition these are intervals when opportunity is far greater than at other times.
This is what Gann wrote : "The Bible says, 'There is a time for everything.' All the laws of nature teach this. There is a time to sow and a time to reap. The four seasons of the year teach us that there is a reaping time and a sowing time, and that we can not reverse this order of nature's laws. It is the same with the stock market. There is a time to buy and a time to sell. You must learn to go with the tide, and not against it.
"History proves that wars break out every 20 to 25 years. It also proves that there is a great wave of Speculation and Boom of some kind in nearly every country every 20 to 25 years. Why do these war periods and boom times come at such regular cycles or intervals? The main cause of these is that human nature never changes. Every 20 years a new generation comes along. They are full of hope, optimistic and are progressive and up-to-date. They are inexperienced. They know nothing of war or of the bitterness of war, because they have never been in a fight. They are anxious to get in to a fight. It is easy for the politicians to induce the young men to go to war, but it is hard to get the old fellows who have had the bitter experience and the suffering, to go to war. They want no more of it. The young buck is wild and always ready to run and to fight.
"It is the same with the commodity market. The young generations either have inherited money or they make money, and they want to take a chance. It is the nature of young to gamble, to take chances, and to be fearless of danger. Therefore, the young generation is anxious and eager to try their hands at speculation."
1.9 - Principles of History Repeating in Various Markets
While it is true that history repeats, it is important to understand that different markets have different personalities. Each market -- whether it is the corn, cotton or stock market -- demonstrates different characteristics, some of which are shared with other markets, and others which are unique to that market. We can learn what their tendencies are by looking at their price moves from the past.
When analyzing historic data we are like detectives. It is like looking for the habits or patterns of criminals to see what they will do next. Based upon the forensic evidence of a market's current move we can determine if there are any close fits in history.
Gann said, "the farther back you have a record of a stock or commodity and the more you study it, the more you will understand its actions and know when it is making tops and bottoms. You should become thoroughly acquainted with the stocks and commodities you trade, and by studying them, you will learn their individual moves which are peculiar to themselves." The trader can then make deductions based on probabilities, not upon hope, fear or guesswork.
A study of history shows you the formations that are made at market highs and lows decade after decade. From this you learn what accumulation or distribution looks like in various commodities. You learn the typical duration of bull and bear markets in normal times and abnormal times. You learn what the runaway portion of a cycle looks like and what kinds of buying or selling corrections are experienced along the way. You learn what a "blow-off" and a crash look like because these will be repeated in the future. By observing past trends, you discover the current position of a market. There are always sister markets from the past that we parallel very closely. These previous market moves give important clues on what our market is going to do.
A review of history reminds us of what markets are capable of -- what is probable and what is not. Since our memories are short, the historic record is there to help us make decisions based upon facts. Listen to what Gann said: "By studying past history and knowing that the future is but a repetition of the past, you can determine the cause according to the time and conditions. Sometimes it is necessary to go a long way back to determine the cause, because you must study war, its effect, the conditions before war and what follows."
1.10 - W. D. Gann's Market Philosophy Lends Itself to Capturing the Major Moves
From the time I picked up Gann's books, 45 Years on Wall Street and How To Make Profits Trading In Commodities, I immediately identified with the practical side of his philosophy that the "big money is made on the big moves." Since that time my desire has been to assimilate and build on Gann's work for the purpose of capitalizing on the major moves the markets have to offer.
Gann said, "The big profits are made in the runs between accumulation and distribution. Therefore, you make more money by waiting until a stock or commodity plainly declares its trend than by getting in before it starts. It is just like a race. It often takes fifteen or twenty minutes to get the horses to the post, but once 'they're off' the race is over in two minutes."
One of the objectives of our research is to identify and participate in the generational moves that take place periodically in each market according to its particular cycle. In order to do this, we must have the means to determine what section of the cycle we are in, and the patience to wait for those opportunities.
1.11 - Summary
In the next several sections we will deal with how Gann quantified the extremes to which the crowd can push prices based upon history. When entering a market, our objective is to buy on weakness and sell on strength. After entering positions our objective is to ride the wave of over-optimism and over-pessimism, which at times pushes prices to "unreasonable" and "unimaginable" levels.
When you look at long stretches of history in many different markets, it requires that you have an organized and systematic way of researching and recalling the past in order to make it useable in the present. This demands that you isolate certain market conditions in the past that have demonstrated a significant probability for launching major moves. That's where Gann's analysis and the Research Engine come into play.
The key is that there is a mathematical basis for the excesses to which people push prices. As you will see, markets move up or down in cycles very close to the same duration as those within previous bull and bear markets. These cycles warn us in advance of the psychological moments of truth when major turning points will occur with the majority of people buying near the top or selling near the bottom. Equipped with this knowledge, we are able to move opposite the crowd and allow the redistribution of wealth to flow into our accounts.
