Q&A
Futures For You
Inside The Futures World
Want to find out how the futures markets really work?
DeCarley Trading senior analyst and broker Carley Garner responds to your questions
about today’s futures markets. To submit a question, post your question
at https://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C. Visit Garner at www.DeCarleyTrading.com. Her books, Commodity Options and A Trader’s First Book On Commodities, are available from FT Press.
Tools, Tools, Tools
What are your thoughts on some of the geometrical technical analysis tools such as Fibonacci rulers, Elliott wave theory, and Gann fans?
Geometric charting tools, sometimes referred to as advanced charting tools, require active decision making by the user. This ambiguity creates an environment in which analysts can draw dramatically different conclusions despite using the same tools. More than with less interactive tools, such as computer-generated oscillators, these advanced charting tools are only as good as the trader using them.
In my opinion, these advanced tools are better at explaining what has already happened than predicting what might happen. But that’s true of all speculative tools.
Fibonacci theory
Most traders are familiar with Fibonacci rulers, but just in case you aren’t, Fibonacci was a 13th-century Italian mathematician considered to be among the most talented Western mathematicians of the period. He was responsible for introducing what is now known as the “Fibonacci sequence,” in which each number is the sum of its previous two numbers, starting with zero and 1:
0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, and so forth
As the sequence progresses, two consecutive numbers divided by each other will approach what is known as the golden ratio, 61.8%; for example, dividing 610 into 987 equals 61.8%. According to Fibonacci theory, nature, and therefore the markets, tend to move in increments of 61.8% based on the golden ratio. The theory suggests market moves will find support or resistance after retracing the following percentages of the initial move:
- 23.6% (found by dividing any number in the sequence by the number that is three places to the right)
- 38.2% (found by dividing any number in the sequence by the number that is found two places to the right)
- 50.0% (midpoint between high and low)
- 61.8% (found by dividing any number in the sequence by the number that immediately follows it)
- 76.4% (found by subtracting 0.236 from 1)
The several possible retracement levels means that for instance, by the time a trader realizes resistance at the 38.2% level didn’t hold, the market is likely to be approaching 50%. This is why I look to Fibonacci as confirmation of my original assessment, but not for decision making outright.
Elliott wave theory
Elliott wave theory is a popular charting method but, like economists and Fibonacci adherents, each Elliott wave theorist has a relatively unique prediction. In such a theory, there are guidelines but also many shades of gray and very little black or white.
Elliott wave theory, which was developed by 20th-century accountant Ralph Nelson Elliott, is based on the premise that market behavior is determined in waves rather than random timing. Similar to Fibonacci theory, Elliott’s followers believe that market prices rise and fall based on the golden ratio.
According to the theory, the market rises in a series of five alternating waves and declines in a series of three alternating waves. The market rises on the first wave, declines on the second, rallies into wave 3, but is followed by a declining wave 4 and finally completes the rally on wave 5. The five-wave sequence is then followed by a three-wave correction, referred to as A, B, and C.
The tool is open to subjective interpretation. For instance, the theory doesn’t attempt to precisely predict the size of any of the waves, and therefore, it can be difficult to base entry and exit points using such a tool. As is the case with any trading tool, this theory should be applied in conjunction with other technical analysis instruments or indicators. In addition, there is no defined starting or stopping point, and therefore, it can be difficult to identify the proper waves until after the fact.
Gann fan
The Gann fan has garnered a cult following in the trading world. Created by trader W.D. Gann, the Gann fan incorporates the use of geometric angles in conjunction with time and price. According to Gann theory, certain geometric patterns could be used to predict price movement.
Although charting software will allow traders to draw Gann fans in numerous ways, Gann intended for the fan to be drawn with equal time and price intervals. By doing so, a rise of one price unit for each time unit is equal to a 45-degree angle. Gann fan theory suggests the ideal balance between time and price exists when prices rise or fall at a 45-degree angle relative to the time axis.
According to this theory, the fan should stem from a major market high or low and be drawn in a way in which the center fan line is on a 45-degree angle. Surrounding the fan line, there are eight other angles that represent various levels of support and resistance. As the market passes through one fan line, prices should move to the next.
Like Elliott wave, Gann fan analysis leaves much of the interpretation to the discretion of the trader. In addition, because the Gann fan involves multiple lines, critics simply attribute support and resistance as coincidence. After all, if you draw enough lines on a chart, some of them are bound to hold!