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RichardCox

Advanced Price Patterns: Gann’s Law of Vibration

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Advanced Price Patterns: Gann’s Law of Vibration

 

The work of W.D. Gann tends to generate mixed responses from traders. These reactions range from outright dismissals to loyal enthusiasm for each of his methods and perspectives. But traders on either side of the fence find it difficult to disagree with the fact that the work of W.D. Gann forms the basis of many commonly use trading approaches in technical analysis. In order to understand Gann’s methods for approaching the financial markets, we must first understand his Law of Vibration, which the introduced in his book, The Tunnel Thru The Air.

 

It can be said that Gann was not the originator of many of the central ideas presented in the book. In fact, Gann himself paid extensive homage to the Christian Bible, specifically citing St. Matthew's Gospel, chapter 12. Religion aside, it is clear that Gann was inspired by St. Matthew’s use of of the gematria -- the ancient science of numbers. So, the foundations of Gann’s approach to the financial markets (the pattern behind the Law of Vibration) extends back more than 1,900 years. But it seems impossible to draw connections between ancient science and modern markets. How exactly does this Gann’s Law operate? What was Gann’s purpose in devising an alternative view of the financial markets.

 

The Work of George Gurdjieff

 

The easiest way of understanding Gann’s approach can be found in the work of George Gurdjieff, which used a simplified approach of the pattern behind the Law of Vibration. Gurdjieff worked from Gann’s focus on the cyclical nature of the markets and looked to benefit from its inner workings during active trades.

 

The idea is that collective market behavior exhibits cyclical activity. These types of terms are also commonly used in Elliott Wave analysis. But, with Gann (and with Gurdjieff’s simplifications), a very different type of structure unfolds. Key differences between Elliott and Gann can be seen in the alternative approach to trends. Many traders would like to believe that Elliott Wave theory is the most accurate way of quantitatively analyzing sentiment in the markets. But when we look at Gann’s approach, we can see a much more realistic representation of the way market participants react to new information and sources of data.

 

Pattern Structure

 

The chart graphic below shows the pattern behind the Law of Vibration, and there some important differences between Gann’s model and the traditional “sine-wave” models that are employed by cycle analysts. In Gann’s model, we can see a much more erratic representation of the market’s reaction to new information. This model does away with the robotic sine-wave structure that defines many cyclical price models. Like it or hate it, Gann’s model much more accurately represents the irrational exuberance that is often found in the market, and the over-extended price corrections that are seen when the reality sets in.

 

znpx02.png

 

Let’s assume that new information presented to the markets is positive for asset prices. When the cycle is separated into a 1-2-3-A-B-C format, an initial bull move is generated by the positive shock of new information. Prices run ahead of economic fundamentals and short term traders take profits, creating a corrective retracement to the downside -- the breakdown phase. This creates an “energy gap” and prices than fall to point A. But since the news was positive, it is unlikely that prices will fall below the price area that marked the beginning of the cycle.

 

The real price move then begins, as traders “apply” the new information and generalized sentiment improves. Once these rallies become over-stressed, a much larger breakdown occurs as the system remains unchanged. Markets then show a more subdued recovery, with the overall trajectory in-line with the direction of the new information that started the cycle. A more real-time example of what this cycle looks like can be found in the graphic below.

 

kao7kl.png

 

Pattern Interpretations

 

So, while some technical analysts dismiss Gann’s work as being overly esoteric, a more simplified interpretation can be seen in the market’s predictable response to new data. As investors absorb new information, cyclical phase activity can be anticipated. These price waves can be used as a reason to scale-in and scale-out of positions, enabling traders to capture a much larger portion of the trend (when compared to those that simply “buy and hold” in trading).

 

As the cycle progresses, price moves tend to be less extreme (i.e. volatility slows) as the system has already absorbed the initial shock and the market majority has already responded to the new information that began the cycle. In this way, Gann’s Law of Vibration provides market insights into the ways the majority reacts and shows cyclical behaviors. In time, the system (and the cycle) will run out of energy and market participants will need a new impulse event to generate major changes in sentiment.

 

Shock, Reversal, Recovery

 

One of the difficulties when using Gann’s model is that it is highly subjective in nature and there are no exact price points that mark the cyclical structure. But while this might discourage some traders from seeing validity in the model, it should be remembered that the same types of criticism can be applied to Elliott wave analysis -- an approach that has gained widespread acceptance in recent years.

 

The best way to approach Gann’s model is with a broad view, and see it in terms of the market behaviors it looks to describe. The initial activity is propelled by a new piece of market information. This, for example, can come in the form of a major piece of economic data or a geopolitical event. Prices than move in the direction of the data (positive or negative), but markets tend to overreact and push prices to an irrational extreme. This leads to a significant reversal, as investors that entered the move too late are now forced to exit their trades. This completes the initial impulse phase of the cycle (moves 1-2-3 shown above). The recovery phase then begins and prices begin a more subdued move in the direction of the original impulse. This move also unfolds in three waves (the A-B-C structure shown above).

 

Percentage Moves

 

Last, the Gann model tends to give approximate time zones for when each wave is likely to unfold. This should not be surprising to those that are familiar with Gann’s work, as most of it focuses on the relationships between price and time. In the chart below, we can see each wave as it relates to a percentage of the entire cycle:

 

35daneu.png

 

The graphic shows each sub-cycle as it relates to the whole. For example, the first price correction (Point 2) tends to unfold near the 25% mark. This percentage framework can be useful for those that are looking to place real trades using the Gann model, as it helps give a better indication of where in time price reversals and continuations are likely to take place.

 

Conclusion: View Gann’s Model as a Representation of Market Behavior

 

There are many traders that actively dismiss the work and models put forward by Gann because of their subjective nature. But it should be remembered that most (if not all) approaches to technical analysis are subject to the same criticism. It is best to view Gann’s model in terms of its representation of market behavior, as there is a good deal of accuracy here in describing human activity in the markets. The underlying pattern in Gann’s Law of Vibration is not always easy to spot. But when we look at the basic structure (information shock, price reversal, trend recovery) along with the expected percentage values in the total cycle, the pattern can start to become visible more quickly.

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