The Gann plan for spread-betting success

What spread bettors need is to develop a systematic approach to getting in and out of the market. The most effective solution here is to use technical analysis combined with a set of trading rules. This helps to take a lot of the emotion and flawed judgment out of spread betting, which are the main reasons for overtrading and poor performance over time.

The theories of WD Gann are especially suitable for spread betting. Gann – who lived from 1878 to 1955 and reputedly amassed a fortune worth $500m in today's money – developed a rich variety of techniques for making investment decisions. Unfortunately, his original writings are confusing even to the experienced technical analyst, and the same goes for much of the literature published by his latter-day disciplines.

Easily the most accessible and effective interpretation of Gann's work is the version developed by a UK firm called Gann Management. Its founder, Fred Stafford, has spent the best part of a lifetime testing and refining the enormous body of knowledge that Gann communicated to the world. Based on this research, his firm has produced a software package that enables easy application of Gann's most valuable secrets to today's markets.

One of Gann's most important insights was that significant highs and lows in traded asset prices are related to one another mathematically. Specifically, he found that a certain set of percentages and angles were constantly at work between major and minor turning points in the markets. Gann believed fractions and multiples of one-half and one-third were especially important.

By applying these various fractions to obvious tops and bottoms in markets, the theory says that traders can spot potential turning points in the market long before they actually happen. The best way to illustrate this principle is in the accompanying chart (top), which has been created using Gann Management's own software package. This shows the price of British Land, the FTSE 100 property share.

Because share prices often move rapidly, a significant high or low in the stock market tend to become obvious fairly rapidly. Having registered an all-time high at the start of last year, British Land started to drop significantly in value. So, the Gann analyst would soon have started to take percentages away from that record peak in order to identify possible reversal levels.

Gann's most important level of all was 50 per cent. In any market, his advice is therefore to add or subtract 50 per cent to or from major peak and trough levels. When dealing with record highs and lows, 50 per cent is often a long way away from current levels. The solution is to divide 50 per cent by half and to continue doing so, giving 25 per cent, 12.5 per cent, 6.25 per cent and so on.

In the case of British Land, we can see that having fallen 12.5 per cent from its all-time peak, it rebounded strongly, retracing almost all the lost ground. The downtrend subsequently resumed, but we have already been alerted to watch the 25 per cent level closely. Several months later, the price has fallen 25 per cent. And, sure enough, another nice little rally kicks in.

The next number in the series is of course 50 per cent. But we don't have to await another massive fall until we might expect a rally. As we mentioned earlier, Gann also highlighted fractions and multiples of one-third as having technical significance. Very often, a price will react at fractions of either one-third or one-half, but not both. Nevertheless, we’d still keep an eye on 33.333 per cent here, just in case. As it happens, 33.33 per cent proves to be effective in the case of British Land. A powerful rally occurs. That rally itself stops at 16.666 per cent – or one half of 33.333 per cent. Apart from reminding us of the enduring power of a simple system of analysis discovered a century ago, this also gives us another interim high point. The Gann analyst isn't only interested in all-time highs and lows but also the many ones in between.

By identifying a range of highs and lows and adding and subtracting percentages from them, the effect is frequently to produce clusters of Gann levels. When you get several Gann levels converging around the same point, it often proves to be an especially reliable turning point. This is especially true once angles are added into the picture, which contribute a whole new dimension.

Just as Gann discovered a specific set of levels that repeatedly connect major and minor tops and bottoms in the markets, he also found that certain angles had major significance. While his most important level was 50 per cent, his most important angle was 45°, which he labelled as being the "square of price and time". Once again, he found that this angle and various others consistently came into play once drawn from pivotal points in the markets.

If you've ever used any technical analysis software package, you may well have stumbled across something called a 'Gann fan'. A set of angles drawn at set degrees, this tool is supposed to be applied to a chart at a significant high or low in order to project lines into the future. This is largely a useless feature thrown in with little thought by software developers who have no understanding of Gann's principles.

The problem is that most software pays no heed to the underlying units of price and time, instead merely drawing fixed lines on a screen. The results generated are therefore almost entirely random. By contrast, Gann Management's approach emphasises the need to control the scaling on the chart and the units of price and time travelled. The accompanying chart of British Land again shows this in action.

The last price activity displayed is the price bouncing off a mildly upward-sloping line. It is a 1x4 daily angle, that is to say it rises at 1 point every four days. The angle is drawn from a major low back in 2003. Having rallied off this level, you can see the price is approaching resistance from a downward sloping line, in this case a -3x1 angle drawn from a minor high in 2008. Where these signals can become especially powerful is where you get a confluence of levels and angles.

Don't be put off by the apparent simplicity of Gann levels and angles. The best ideas in the markets and, indeed, life as a whole are often the most elementary ones. And as you start to look for these levels in the markets, you will be struck by just how often they crop up. While the concept is simple enough, that's not the same as saying Gann theory is easy in practice. Learning Gann's other techniques, scrutinising the charts and then actually deciding to act on the signals requires time and patience.

Given Gann's emphasis on turning points, it should be plain to see how this approach might be handy when spread betting. As a trader you are able to identify key levels in the future where an important development might occur. This may be a matter of pennies or a few days away. Or it could be a huge distance in price terms and many years away. In any event, Gann analysis gives you more advance warning of what to look out for than pretty much any other charting approach.

Once you've identified a precise level on the chart (top), you can then prepare to make your bet if and when the time comes. It is important to stress that the time may not come. Gann levels should be treated as decision points, rather than surefire signals.

Having picked out a place where you believe a share price might reverse in the future, you then wait to see if it actually does so. Once it does, you can place your buy or sell order, with a tight stop-loss nearby in case the market moves contrary to your expectations. If the reversal doesn't happen, you simply take no action and wait for another level or look at a different asset altogether.

Especially if you're a newcomer to all this, nothing quite beats seeing all this demonstrated live on a screen in front of you. So, if this has caught your interest, I would recommend that you attend one of the free seminars that Gann Management regularly organises. For more information visit the www.gann.co.uk or call 0161 285 4488.