Two names synonymous with Technical Analysis are Gann and Elliott, each having their die hard followers. As in many walks of life, people claim their area of study to be the best. Just look at diets, martial arts, weight loss programs or anything related to some kind of personal improvement. Practitioners of each style or method claim theirs is the best, hands down. The funny thing is most work in a similar manner to the same end. Trading in many ways is no different. I am a fan of the saying, “If it works use it!!”
My research into relationships within Elliott Wave patterns has led to some interesting discoveries that support a theory used heavily in Gann analysis. Before I explain what these are, let's look at how this conclusion was reached.
In building the ProfitSource software, we decided that we needed to be able to give targets as to where Waves within an Elliott pattern would finish. In other words, time and price projections – what we call TAPPs. To do this, 20 years of data and over 30,000 completed Elliott Wave patterns were analysed.
What we found was that if you compare the length in price of Wave 4 with the length in price from the start of Wave 1 to the end of Wave 3 (0-3), a clear pattern emerged. That pattern was essentially this, 66% of all retracements finished on or before 38% of the major range – in this case 0 – 3. Where do we recognise this from? The meaning of life, the universe and everything? Gann's favourite number? No, in fact, 38.2 is a Fibonacci ratio derived from the Golden Ratio.
The first chart below shows Broadcom’s (BRCM:NASD) recent rally out of a Wave 4 retracement. Note the Wave 4 low falls very close to 38.2%.
Chart 1 - 38% Retracements
click to enlarge
Moving on from this, 90% of all Wave 4's finished at or before 50% of 0 – 3. For those acquainted with Gann, you will no doubt recognise 50% as a figure to which Gann paid particular attention. Seeing the significance of the 50% figure proven by statistical analysis was obviously an interesting discovery, especially for someone who has studied W. D. Gann and David Bowden's work. Chart 2 below highlights an example of a market, in this case Equity Residential (EQR: NYSE), bouncing off almost exactly 50% during a downward five wave count.
Chart 2 – 50% Retracements
click to enlarge
Jumping back a bit, 38.2% is also very close to another Gann number – 37.5%. Again we can see the similarity in the two approaches.
It’s important to remember that watching retracement levels should only ever be a gauge. It is not an exact science and trading strategies should reflect this. By that I mean trades should not be entered simply because a market has just touched a 38.2% or 50% level alone.
For those not accustomed to Elliott, all the talk about Wave 4 retracing against Waves 0 – 3 can easily be boiled down to a retracement against a major range, high to low or low to high.
So the next time a market bounces off the 50% level from a previous major range, remember that Gann was teaching that long before the kind of analysis we have at our fingertips was ever available. The philosophical question for all of us is, “Do these levels and patterns work because they occur in all walks of nature or are they self-fulfilling prophecies?” Personally I think it's a bit of both!