Breaking Old Highs
As technical analysts, we accept the notion that there are mathematical rules that govern the prices of stocks and commodities. Nevertheless, it is important to remember that it is the buying and selling by human beings that make the market. Prices respond to supply and demand. An excess of supply will cause prices to fall and an excess of demand will cause prices to rise.
Prices seek the point of balance - where supply and demand have equal force - but in reality the market is a continually oscillating pendulum that moves back and forth from an overbought to an oversold position. This produces swing tops and swing bottoms and exists in any time frame. A sudden surplus of buyers over sellers (or vice versa) will cause a rapid move up or down, in the same way that air fills a vacuum.
Gann said that natural laws apply to the markets and these enable us to identify the points where price should meet resistance on the way up or support on the way down.
Price resistance often occurs at old highs and the reason for this is not difficult to understand. People who bought at the previous high will still be holding onto their stock, hoping to get their money back. When the price reaches that level again they sell and this causes prices to fall back again.
But every so often prices do not reverse at the old high and instead push through and go higher. This can be a sign of much higher prices to come. The extent of this move depends on various factors but one of them is the time that the market has spent in its old trading range. If it has spent many years at that level, the move can be significant.
Gann analyses just such an example in Truth of the Stock Tape, using a stock called Corn Products. This stock spent more than 10 years in a range between $7 and $28, making several highs and lows around these levels. When it eventually broke above the old highs, it climbed to $105 over the next three years and three years after that it was at $134.
Let’s look at a more modern example. Occidental Petroleum (OXY) trades on the New York Stock Exchange. It has been trading for many years, but we have data from 1982. For many years the high was $19.82, made in 1987. In 1989, 1997 and 2001 it made three lower highs at 15.50, 15.38 and 15.55.
Chart 1 – OXY Monthly
click chart to enlarge
In April, 2003 it reached the 15.50 level for the fourth time. Gann’s rule is that the market usually breaks through at the fourth attempt and indeed that is what occurred here. The next challenge was the 1987 high, which was, in all probability, the All-Time-High for this stock. As you can see from the monthly chart in Chart 1, it rocketed through this level in December, 2003.
What would we expect to happen next? Here is Gann’s answer:
“The longer the time that elapses between the breaking into new territory, the greater the move you can expect, because the accumulative energy over a long period naturally will produce a larger movement than if it only accumulated during a short period of time.”
Chart 2 tells the story:
Chart 2 – Breakout
click chart to enlarge
In the four years following the breakout, the price of OXY went from $20 a share to $100. After the collapse in oil prices in the second half of 2008 it fell to $40 before rallying to its current All-Time-High of $117.89 in May, 2011.
This example illustrates the value of studying monthly charts and watching old high prices from many years back. How many people would have expected a 500% rise in price after it had been so low for so long? If you are prepared for big moves like this, you will be able to stay with the trend and trade for an extended campaign.
Knowledge is Power!