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No doubt you are all familiar with Gann’s rule that the safest place to sell is the first lower top. But what constitutes a ‘first lower top’? It could be a 1, 2, 3 day or weekly swing top, and it might not be immediately apparent which one you should use.
Take, for example, LGL. (By the way, this will be the last time we will be able to talk about it, as the stock goes off the board at the end of August due to the takeover by Newcrest Mining.) On 28 June it recorded its all-time high price of 4.48. This was 3 cents higher than the previous high of 4.45 on 29 October 2007. This is a double top in anybody’s book, especially as it couldn’t close above the old high.
You would be justified in looking for the first lower top to take a short trade. One duly arrived on 1 July, although a gap down the next day made it difficult to get on board. This was followed by an ABC trade on 8 July that suffered a ‘bad outside day’. By now you’d probably be thinking that there must be a better stock to trade somewhere.
On 14 July the market took out the 1 July swing high by 1 cent, but closed below the previous top. Thus we now have a first lower top that is a double top.
Chart 1 – Initial Move off the High
click chart to enlarge
This would be a good time to take a look at a different perspective. Changing from a 1-day to a 2-day swing chart made the high of 14 July the first lower 2-day swing top. A down day on 15 July offered a 2-day ABC short trade. This was confirmed the next day with a gap down and a ‘short the Openers’ signal.
That day the market narrowly failed to reach the 50% milestone; however, if you rounded the figure towards you, it was just touched. On 19 July there was another gap, this time past the 50% milestone, which the market couldn’t close. This would have you thinking that a big move was underway.
But look what happened next. As the days went by the downward move ran out of steam. Finally, on 28 July there was another gap on Open, but this time the gap was closed and an outside reversal day formed. If you look closely though, the gap took the trade past the 100% milestone.
Chart 2 – 2-Day Short Trade
click chart to enlarge
I had a discussion on the Forum with a trader who was in this trade and was looking to manage stops above swing tops. We often joke that you won’t know the best way to manage your position until a few days after the trade is completed. For this reason the 3 Contracts System taught at the ITW can be very handy. For an exercise you might want to see how your trade would have fared managing your stops in this way.
As far as I am aware Gann never taught his students to take profits on milestones of previous ranges. He simply used swing tops and bottoms. We have David Bowden to thank for adding this additional element to our trading plan, for markets frequently reverse after replicating previous ranges on daily, weekly or even monthly charts.
This example illustrates the need to be flexible in your approach to analysing and trading a market, and shows that with good money management profits can be made even in tricky situations.
Knowledge is Power!
Tim Walker
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