JOHN W. HENRY – AN AUTOPSY OF ONE OF THE GREATS

We’re starting to get a little morbid around here – first with the “Is Trend Following Dead?” piece a couple weeks back, and now an “autopsy” of sorts on what went wrong at John W. Henry’s self-named firm. Some of the sales teams in the industry may prefer to avoid discussing such subjects, probably thinking something along the lines that doing so will “scare away the customers,” but to hear that John W. Henry was shutting down his eponymous managed futures shop was the kind of news that draws us like a moth to a flame.

Here was an industry stalwart in every sense of the word. A man who helped put managed futures on the map, and helped his pocket book to the tune of becoming a billionaire. He is a literal Hall of Famer, having received the Futures Hall of Fame award (whatever that is) from the Futures Industry Association. This isn’t quite Paul Simon hanging up his guitar, or Steven Spielberg deciding to get out of the movie business – but it’s close in terms of shock factor in the managed futures space.

This raises one huge question - well, actually, it raises hundreds of questions - but the big one is this: what in the world happened? We don’t just mean this week in the announcement that he was done, either. What happened in the past 8 years to transform a behemoth into a blip on the radar? Where did John Henry go wrong? Eight years ago he was managing $3 Billion and on top of the managed futures world, with a hot young upstart called Winton measuring in at only about 1/3 the size of Henry’s managed futures empire.

Why was 2004 the top for Henry, yet just a launching point for Winton and other billion-dollar managers?  But most importantly for investors - how can we learn to identify when a top-tier managers’ best days are behind them?

Did he take his eye off the ball?

Excuse the all too easy baseball pun here – but the easy answer for many is to say things started to go downhill when Henry started to stray from his managed futures roots and dabble in sports, buying the Florida Marlins, then Boston Red Sox, a Nascar team and an English soccer squad. If he had only spent less time analyzing pitchers and trying to hire the next Billy Beane – and instead spent more time researching new models and risk parameters for his CTA – then things might have been different… or so the logic goes. 

This would be exactly the kind of shift that an ongoing due diligence program is designed to catch, and something we wrote about not long ago in a newsletter. The general idea is that by staying in close contact with a manager, you can get a feel for when things might be going awry in a way that might impact performance. There is never a guarantee that you'll see the curve ball coming, but you've always got a better chance of it if your eyes are open. 

The problem is that this logic starts to fall apart when we look at just when Henry started these other business ventures, which, according to the Disclosure Document for the JWH programs, began as early as 1987:

“Since the beginning of 1987, [Henry] has devoted, and will continue to devote, a substantial amount of time to business other than JWH and its affiliates.” 

Even if we use the later date of 1998, according to a great 2007 blog post (they had blogs back then?) from the now-deceased Greg Newton (as if this story wasn’t morbid enough already), the shift of focus to include a sports empire doesn’t appear to have affected the performance (which held up until the end of 2004).

His heavy-duty distractions did not begin until he became involved in major league baseball… Henry bought the Florida Marlins in 1998. 

Maybe it’s the Boston Red Sox curse, which Henry supposedly lifted by bringing a World Series title to Beantown? He became involved there in 2002, and things have been bad on the managed futures side for most of the time since.

So while the brains of the operation shifting his focus to baseball seems like an easy due diligence red flag, the numbers don’t really support it as the cause of the decline. Regardless, any investor after the year 2000 would have known of this concern.

A more nuanced “taking his eye off of the ball” argument – and something to consider when conducting due diligence on a manager – is the number of programs in the stable. For JWH, the answer is: quite a few. There are 17 different “capsule performance” tables in the JWH D-Doc. This can be another worry in the due diligence process – can a manager run 17 world-class programs at once? And if not, which would you rather see: 17 mediocre programs, or 1 excellent one?

It’s a plausible story, but in this case, perhaps a more likely culprit in terms of “who’s minding the store” is the high manager turnover.

Manager turnover

So if the boss isn’t always running things, you had better have a very high level of confidence in whoever is picking up the slack. Leadership transitions are often due diligence red flags, but as it turns out – this one isn’t all that straightforward, either.

We’ll borrow heavily from Greg Newton in parsing the Disclosure Document and news clippings on Henry company hires here:

Like those stomach-churning drawdowns, management turnover is nothing new at JWH. Before Rzepczynski’s record tenure ended in January [Others shown the door at much the same time as Rzepczynski included long-time marketing executive Ted Parkhill; Bill Dinon, head of sales; and Andrew Willard, director of technology], past holders of the president title included Verne Sedlacek, now president and chief executive officer of Commonfund; Bruce Nemirow, now a principal of Capital Growth Partners, a third-party marketing company; and Ken Tropin, who, after a distinctly less than amicable split with Henry, went on to found Graham Capital Mgt Inc in 1994. That firm’s assets passed JWH’s several years ago.

Between Nemirow and Sedlacek, Peter Karpen, a former chairman of the Futures Industry Association; and David Bailin, now head of alternative investments at US Trust, held similar responsibilities, without the title of president.

It’s easy to look back on it in hindsight and say that a bunch of people jumping ship in 2007 was a bad sign, but consider how it looked in the moment: the person leaving had been there 9 years, while the person replacing him had been there 12 years. That certainly doesn’t look so bad, especially when compared with a program (Winton) which is just getting started or a management team with 5 years or less of experience.

Adapt or Die (but careful with those adaptations)

Did hubris play a part? Again, from Greg Newton:

JWH generally has not changed the fundamental elements of the portfolios due to short-term performance, although adjustments may be, and have been, made over time. In addition, JWH has not changed the basic methodologies that identify signals in the markets for each program. JWH believes that its long-term track record has benefited substantially from its adherence to its models during and after periods of negative returns; however, adherence to its strategy may lead to prolonged periods of market losses and high risk, according to its current disclosure document.

Did a stubbornness to adhere to the models which had worked in the 80s, 90s, and start of this century cause those models to become outdated? That seems doubtful. As we say around here, “Systems don’t break, they just become more risky.” It would appear that this is exactly what happened to JWH. Of course, some on the risk management side of a successful CTA might say that a model becoming more risky is the same thing as that model breaking. After all, the risk is the most important part. And we wouldn’t argue too much there.

In the end, it looks like it may have been the worst of both worlds for Hentry: sticking with the base models but tweaking the position sizing. Per page 34 of the JWH D-doc, we learn that the position sizing has been changed 16 times across 9 programs since 2003.  And these weren’t all position size reductions – many were increases. On one hand, if you are taking losses at a high trading level, then trying to gain those losses back at a reduced level, it’s going to take much longer to return to profitability. But if those losses we due to unresolved flaws in your trading method, raising your position sizes is just doubling down on a losing strategy.

Live and Die by the Volatility

Most of those in the industry will tell you John W. Henry was simply too volatile for modern tastes, and you can see when taking a look at his programs’ track records some big numbers on both sides. Take the financials & metals 36% annualized volatility for example, or the multiple years with above 40% gains or more than -17% losses, and you can see that Henry’s model was one of high risk for high return.

But it’s more than just the fact that the JWH programs were volatile – what stands out is how much more volatile they were than “normal” and the fact that they were getting more volatile compared to the competition.

The above look at the ratio between the JWH composite’s rolling 12mo annualized volatility and that of the BarclayHedge CTA Index shows that the JWH programs were about 2.25 times more volatile, on average, than the index during their boom times (the first 20 years), and had jumped to 3.49 times more volatile, on average, in the past 8 years.

Again, this is something more easily seen with hindsight, but this is easy enough to analyze in real time. It’s especially concerning how volatile a program is not just in absolute terms, but in relation to its benchmark as well. And if it’s 5 times more volatile – as JWH was a few times in 2008 – you had better be sure you are getting 5 times more the return as well.

Which brings us to…

You have to make money

At the end of the day in this business (or any other), no amount of name recognition nor bulletproof due diligence can make up for the failure to make money for your clients over a five year period, and that, more than anything else, led to John W. Henry closing up shop.

Consider the Financials & Metals program again. Heading into 2005 the program had never experienced back-to-back losing years. In fact, only once had the program suffered more than 1 losing year in any 7 year period (losing two out of three between 92 and 94). The program then saw losses in three consecutive years between 2005 and 2007, and when including this year’s down performance, the program has now lost money in 5 of the past 7 years.

 The three years of losses ending in 2007 are likely what led to Merrill pulling the plug in that year (right before the program experienced a big bounce back, but that’s a topic for later), but the table above shows that something is materially different in the past eight years when compared to the first 20 for the Financials & Metals program.

A CTA’s job is twofold. First, to generate absolute return performance, so that a customer who gives the program at least three years to do its job will be rewarded with positive performance. And second, to stay ahead of the competition.

It’s no easy task, to be sure, and John Henry’s gold-lined trash cans are probably filled with the brochures of contenders who tried and failed. But since 2004, it has been Henry’s programs which have failed on both counts. They haven’t remained positive across the bulk of the rolling three year periods, with some of the rolling three year returns falling below -20%. And while those years haven’t been kind to many other CTAs, JWH failed to stay ahead of the competition. They spent most of the past eight years with rolling 36 month returns below that of the BarclayHedge CTA Index.

Henry was lagging the index and seeing large negative 36 month returns as early as 2005, meaning there were chinks in the armor that appeared well before Merrill pulled the plug in 2007.  But pulling the plug on an underperforming advisor has to be one of the hardest things to do for the individual investor. Especially when you are considering pulling the plug on a Hall of Famer.

It’s all Relative

It’s a zero sum game, as managed futures detractors like to say. But the reality is that it is not that black and white. There isn’t always one clear winner and one clear loser. It’s more like a few thousand winners, a few thousand losers, and many more in between.

The job of the investor, then, isn’t necessarily to find the winner and avoid the loser, but to find the one doing a better job of winning than the others. What does that mean? Providing return with less volatility, more consistency, experiencing smaller drawdowns, shorter drawdowns – the list goes on.

Which brings us back to Henry. You see, while he is up (big time) in the zero sum game overall, the biggest takeaway for us following this pseudo-autopsy on the John W. Henry programs was in how the program started to become one of the worst winners according to our ranking algorithm.

The biggest warning flag to us was seeing how his ranking fell despite the program going on to make new equity highs.

You see, we don’t just rank on performance – we rank on comparative performance, across many time frames, and incorporate risk metrics to normalize the performance across programs. So you not only have to do well – you have to play the game better than the next guy in terms of controlling risk, delivering consistency, and more.

The fact that the John Henry programs started to fall in our rankings after their 1999 drawdowns is a sign of poor relative performance. In other words, they weren’t just doing poorly because of a bad managed futures environment – they were doing poorly AND performing worse than their peers were in that same environment. You can get away with rough years, but you can’t do worse than your peers for an extended period of time and hope to stay in the game.

Lessons Learned:

Don’t cry for Henry – he’s doing just fine: still worth $1.5 billion, and the 389^th richest person in the US according to Forbes.

But do pay attention to the potential lessons within this story:

1.       Past performance is not necessarily indicative of future results. It’s not just a disclaimer, and the performance of the Henry Financials & Metals program shows the reality of that – with winning years in 17 out of its first 20 years followed by losing ones in 5 out of 7.

2.       Know what sort of program you are getting involved with. John Henry’s programs were notoriously high volatility, and willing to take larger losses in exchange for home-run type years - meaning  losses of -20% and more shouldn’t have surprised anyone.

3.       Beware the big brokerage house (Merrill Lynch types) selling a big brand name managed futures program. While Henry was a poster child for managed futures as late as 2004, there were warning signs for his programs well before that.  The big brokerages believe they are being conservative when selecting the well-known program with a long history of success, but they could be better served identifying lesser-known programs with the risk and reward profile their clients want. They are often late to the party and late to get out.

4.       Henry is still a Hall of Famer. Yeah, we know… we said there were warnings, his main program has our lowest ranking, and we wouldn’t recommend a JWH program for our clients. But having said all that, he also made a lot of money for a lot of people in his early days (and knowing how these things cycle he’ll likely go on to make himself another small fortune just by trading his own money). We’ve never met him, and don’t know what sort of person he is – but we’re willing to bet that many of the clients involved with him during the ‘80s and ‘90s still think he’s worthy of that hall of fame distinction. 

greed and fear

The biggest hurdle an investor faces are the twin emotions of greed and fear. Most gamblers don’t seem to be influenced by the latter, but the former is powerful enough.

Trading Strategies of the Rich and Famous: John W. Henry

Unless your a Red Sox fan, you might not have heard of John W. Henry. When it comes to the lexicon of great traders, John W. Henry doesn’t hold a candlestick chart to guys like Warren Buffett and Richard Dennis. But he should be there.

One thing you notice about great traders is there’s no such thing as a “pedigree.” They don’t all come from Ivy League schools. They don’t all start investing early. A lot of traders don’t even have a financial background.

Henry was from a farm family. He went to Victor Valley College and spent a stint at the University of California. What was his major? Finance? Economics? Nope. Philosophy. He didn’t graduate, by the way.

Despite this unconventional background, in the late 1970s, Henry began to trade. First, he traded something he was familiar with–soybeans and corn futures. But, Henry eventually created and tested a systematic trend trading strategy for multiple assets, mostly commodities.

The tests proved successful. That’s an understatement.

If you could reduce Henry’s trading strategy to its core principals, the two most significant would be:

1. Always be in the market.
Hold a basket of assets and either be in short or long positions, depending on the trend. (That last bit is key. You have to develop a systematic measure for determining the trend.)

2.  No emotions.
This is a mechanical system It’s not based on hunches. Or intuition. Or gut feel. Etc.

3. Fundamentals are not fundamental.
It may seem counter intuitive, but the analysis of fundamentals can be subjective. Like a child seeing shapes of cartoon figures in the clouds, a trader can see patterns in fundamentals that simply don’t exist. He or she is imprinting emotions on the numbers. All analysis must be objective and  devoid of emotions.

We believe that an investment strategy can only be as successful as the discipline of the manager to adhere to its requirements in the face of market adversity. Unlike discretionary traders, whose decisions may be subject to behavioral biases, our traders apply a disciplined investment process. By quantifying the circumstances under which key investment decisions are made, our methodology offers investors a rational approach to markets, unswayed by judgmental bias–from John W. Henry & Company website.

A more thorough summary of Henry’s methodology is available at his company’swebsite.

The system works apparently. If you remember the Barings bank debacle when Nick Leeson, a supposed rogue trader, made ridiculous bets on the Nikkei, Henry was on the winning side of that trade. The key was finding the trend.

“There are trends that tend to exist, whether they are capital flows or interest rates. So you can call trend following a blackbox, I guess, because some people refer to disciplined, mechanical-type trading as blackbox. But if you have enough discipline, or you only trade a few markets, you don’t need a computer to trade this way. It just makes it much, much more convenient for us.” – John W. Henry, Future’s Industry Association.

Henry fluctuates between billionaire and multi-millionaire status. (His net worth is currently estimated at $840 million.) A lifelong baseball fan, he owns the Boston Red Sox. He also owns the Liverpool Football Club.

William %R

Introduction

Developed by Larry Williams, Williams %R is a momentum indicator that is the inverse of the Fast Stochastic Oscillator. Also referred to as %R, Williams %R reflects the level of the close relative to the highest high for the look-back period. In contrast, the Stochastic Oscillator reflects the level of the close relative to the lowest low. %R corrects for the inversion by multiplying the raw value by -100. As a result, the Fast Stochastic Oscillator and Williams %R produce the exact same lines, only the scaling is different. Williams %R oscillates from 0 to -100. Readings from 0 to -20 are considered overbought. Readings from -80 to -100 are considered oversold. Unsurprisingly, signals derived from the Stochastic Oscillator are also applicable to Williams %R.

Calculation

%R = (Highest High - Close)/(Highest High - Lowest Low) * -100

Lowest Low = lowest low for the look-back period
Highest High = highest high for the look-back period
%R is multiplied by -100 correct the inversion and move the decimal.

The default setting for Williams %R is 14 periods, which can be days, weeks, months or an intraday timeframe. A 14-period %R would use the most recent close, the highest high over the last 14 periods and the lowest low over the last 14 periods.

Click here to download this spreadsheet example.

Interpretation

As with the Stochastic Oscillator, Williams %R reflects the level of the close relative to the high-low range over a given period of time. Assume that the highest high equals 110, the lowest low equals 100 and the close equals 108. The high-low range is 10 (110 - 100), which is the denominator in the %R formula. The highest high less the close equals 2 (110 - 108), which is the numerator 0.2 divided by 10 equals 0.20. Multiply this number by -100 to get -20 for %R. If the close was 103, Williams %R would be -70 (((110-103)/10) x -100).

The centerline, -50, is an important level to watch. Williams %R moves between 0 and -100, which makes -50 the midpoint. Think of it as the 50 yard line in football. The offense has a higher chance of scoring when it crosses the 50 yard line. The defense has an edge as long as it prevents the offense from crossing the 50 yard line. A Williams %R cross above -50 signals that prices are trading in the upper half of their high-low range for the given look-back period. This suggests that the cup is half full. Conversely, a cross below -50 means prices are trading in the bottom half of the given look-back period. This suggests that the cup is half empty.

Low readings (below -80) indicate that price is near its low for the given time period. High readings (above -20) indicate that price is near its high for the given time period. The IBM example above shows three 14-day ranges (yellow areas) with the closing price at the end of the period (red dotted) line. Williams %R equals -9 when the close was at the top of the range. The Williams %R equals -87 when the close was near the bottom of the range. The close equals -43 when the close was in the middle of the range.

Overbought/Oversold

As a bound oscillator, Williams %R makes it easy to identify overbought and oversold levels. The oscillator ranges from 0 to -100. No matter how fast a security advances or declines, Williams %R will always fluctuate within this range. Traditional settings use -20 as the overbought threshold and -80 as the oversold threshold. These levels can be adjusted to suit analytical needs and security characteristics. Readings above -20 for the 14-day Williams %R would indicate that the underlying security was trading near the top of its 14-day high-low range. Readings below -80 occur when a security is trading at the low end of its high-low range.

Before looking at some chart examples, it is important to note that overbought readings are not necessarily bearish. Securities can become overbought and remain overbought during a strong uptrend. Closing levels that are consistently near the top of the range indicate sustained buying pressure. In a similar vein, oversold readings are not necessarily bullish. Securities can also become oversold and remain oversold during a strong downtrend. Closing levels consistently near the bottom of the range indicate sustained selling pressure.

Chart 3 shows Arch Coal (ACI) with 14-day Williams %R hitting overbought and oversold levels on a regular basis. The red dotted lines mark a move below -50 that occurs after an overbought reading. The green dotted lines mark a move above -50 that occurs after an oversold reading. As noted above, overbought is not necessarily bearish and oversold is not necessarily bullish. Top and bottom pickers can act when overbought or oversold, but it is often prudent to wait for a confirmation move. A move below -50 confirms a downturn after an overbought reading. A move above -50 confirms an upturn after an oversold reading.

Momentum Failure

The failure to move back into overbought or oversold territory signals a change in momentum that can foreshadow a significant price move. The ability to consistently move above -20 is a show of strength. After all, it takes buying pressure to push %R into overbought territory. Once a security shows strength by pushing into overbought territory more than once, a subsequent failure to exceed this level shows weakening momentum that can foreshadow a decline.

The chart above shows Cisco with 14-day %R. The stock was strong with numerous overbought readings from February to April. Even after the plunge below -80 in early April, %R surged back above -20 to show continuing strength. After a few more weeks of overbought readings, %R plunged to oversold levels in early May. This deep plunge showed strong selling pressure. The subsequent recovery fell short of -20 and did not reach overbought territory. This provided the second sign of weakness. After failing below -20, the decline below -50 signaled a downturn in momentum and the stock declined rather sharply. Another failure just below -20 in mid June also resulted in a sharp decline.

The chart above shows TJX Companies (TJX) with 28-day Williams %R. Chartists can adjust the look-back period to suite their analysis objectives. A longer time frame makes the indicator less sensitive. After becoming overbought in October, the indicator moved lower and became oversold twice in December. The January surge carried %R into overbought territory and the stock broke channel resistance. These were promising signs. On the subsequent pullback, %R held above -80 and did not become oversold. This showed underlying strength. The subsequent move above -50 foreshadowed a sharp advance over the next few months.

Conclusions

Williams %R is a momentum oscillator that measures the level of the close relative to the high-low range over a given period of time. In addition to the signals mentioned above, chartists can use %R to gauge the six month trend for a security. 125-day %R covers around 6 months. Prices are above their 6-month average when %R is above -50, which is consistent with an uptrend. Readings below -50 are consistent with a downtrend. In this regard, %R can be used to help define the bigger trend (six months). Like all technical indicators, it is important to use the Williams %R in conjunction with other technical analysis tools. Volume,chart patterns and breakouts can be used to confirm or refute signals produced by Williams %R.

Using with SharpCharts

Williams %R is available as an indicator for SharpCharts. The default setting is 14, but users can opt for a shorter timeframe to produce a more sensitive oscillator or a longer timeframe to produce a less sensitive oscillator. Once selected, the indicator can be place above, below or behind the underlying price plot. Click on “advanced options” to add a moving average, horizontal line or other indicator. A 3-day SMA can be added as a signal line. Click here for a live example.

Suggested Scans

Williams %R Turns Up from Oversold Levels: This scan searches for stocks that are trading above their 200-day moving average to define a long-term uptrend. A pullback is identified when %R moves below -80 and a subsequent upturn occurs when %R moves above -50.

Williams %R Turns Down from Overbought Levels: This scan searches for stocks that are trading below their 200-day moving average to define a long-term downtrend. An oversold bounce is identified when %R moves above -20 and a subsequent downturn occurs when %R moves below -50.

Classic Trend Following Advice from John W. Henry the Owner of the Boston Red Sox

If there was a Hall of Fame for trend followers the owner of the Boston Red Sox would be in it. A piece of timeless wisdom from John W. Henry:

How are we able to make money by following trends year in and year out? I think it’s because markets react to news, but ultimately major change takes place over time. Trends develop because there’s an accumulating consensus on future prices, consequently there’s an evolution to the “believed true price value” over time. Because investors are human and they make mistakes, they’re never 100 percent sure of their vision and whether or not their view is correct. So price adjustments take time as they fluctuate and a new consensus is formed in the face of changing market conditions and new facts. For some changes, this consensus is easy to reach, but there are other events that take time to formulate a market view. It’s those events that take time that form the basis of our profits.

Investment

Use:
Guppy
EMA 8 14
RSI

to time the enter and exit of good FA stock

all psychological

use both fundamental and TA

but I cant use fundamental, no way to match big research company....


TA can only be use short term trading, not long term,,,

so find good FA stock, monitor and wait for the price to crash and then buy

FA cant be use ??? so how to know when is the bottom.. ??
but it reflect the psychological thinking of the masses at he time, so use to gaude the thinkinh of these investors, thus can be use for Guppy....

Is Technical Analysis a Waste of Time?

There are some investors who believe they can profit by finding patterns in historical stock prices or trading volume. These investors are attempting to profit from technical analysis. Kevin Grogan, my colleague at Buckingham Asset Management, reviewed some evidence on these strategies and found that these investors could probably find a more productive use for their time.

William Eckhardt (trader)

William Eckhardt is a commodities and futures trader and fund manager. He began trading in 1974 after four years of doctoral research at the University of Chicago in mathematical logic.

Education

Eckhardt never finished his PhD in mathematics, claiming that he left graduate school for the trading pits after an unexpected change of thesis advisors. Despite leaving academia prematurely, Eckhardt has published several papers in academic journals. In 1993, Eckhardt's article "Probability Theory and the Doomsday Argument" was published in the philosophical journal Mind. His follow-up article, "A Shooting-Room view of Doomsday" was published in The Journal of Philosophyin 1997. Both articles make arguments skeptical of the Doomsday Argument as formulated by John Leslie. In 2006, he published "Causal time asymmetry" in the journal Studies In History and Philosophy of Modern Physics.

Career

In 1991 he founded Eckhardt Trading Company ("ETC"): an alternative investment management firm, specializing in the trading of global financial futures andcommodities, which manages over $1 billion in managed accounts, domestic and offshore products. The firm's international clientele includes "fund of funds", corporate, private, and institutional investors.

Having a strong analytical and mathematical background, Eckhardt believes that the correct application of statistics and mathematical concepts is key for successful trading.^[1] However, he highlights the difficulties in using these concepts, mentioning that "the analysis of commodity markets is prone to pitfalls in statistical inference, and if one uses these tools without having a good foundational understanding, it’s easy to get in trouble".

Prior to founding ETC, Eckhardt was also involved in the Turtle Trading experiment,^[2] set up by partner, friend and fellow trader Richard Dennis. The goal of that experiment was to settle a philosophical disagreement between the two partners, to determine whether the skills of a successful trader could be reduced to a set of rules (i.e. can trading be taught?). The experience was overwhelmingly successful with novice traders ending up making $100 million. Eckhardt, who believed trading could not be taught, had effectively lost his bet with Dennis.

How To Use Gann Indicators

Gann studies have been used by active traders for decades and, even though the futures and stock markets have changed considerably, they remain a popular method of analyzing an asset's direction. New trading areas, such as the foreign exchange market and the invention of exchange-traded funds (ETFs) have also made it necessary to revisit some of the construction rules and application concepts. Although the basic construction of Gann angles remains the same, this article will explain why the changes in price levels and volatility have deemed it necessary to adjust a few key components. (For background reading, see A Discussion of Gann or The Gann Studies)

Basic Elements of Gann TheoryGann angles are a popular analysis and trading tool that are used to measure key elements, such as pattern, price and time. The often-debated topic of discussionamong technical analysts is that the past, the present and the future all exist at the same time on a Gann angle. When analyzing or trading the course of a particular market, the analyst or trader tries to get an idea of where the market has been, where it is in relation to that former bottom or top, and how to use the information to forecast future price action.

Gann Angles Versus TrendlinesOf all of W.D. Gann's trading techniques available, drawing angles to trade and forecast is probably the most popular analysis tool used by traders. Many traders still draw them on charts manually and even more use computerized technical analysis packages to place them on screens. Because of the relative ease traders today have at placing Gann angles on charts, many traders do not feel the need to actually explore when, how and why to use them. These angles are often compared to trendlines, but many people are unaware that they are not the same thing. (To learn about trendlines, see Track Stock Prices With Trendlines.)

A Gann angle is a diagonal line that moves at a uniform rate of speed. A trendline is created by connecting bottoms to bottoms in the case of an uptrend and tops to tops in the case of a downtrend. The benefit of drawing a Gann angle compared to a trendline is that it moves at a uniform rate of speed. This allows the analyst to forecast where the price is going to be on a particular date in the future. This is not to say that a Gann angle always predicts where the market will be, but the analyst will know where the Gann angle will be, which will help gauge the strength and direction of the trend. A trendline, on the other hand, does have some predictive value, but because of the constant adjustments that usually take place, it's unreliable for making long-term forecasts.

Past, Present and FutureAs mentioned earlier, the key concept to grasp when working with Gann angles is that the past, the present and the future all exist at the same time on the angles. This being said, the Gann angle can be used to forecast support andresistance, strength of direction and the timing of tops and bottoms.

Gann Angles Provide Support and Resistance

Source: TradeStation

Using a Gann angle to forecast support and resistance is probably the most popular way they are used. Once the analyst determines the time period he or she is going to trade (monthly, weekly, daily) and properly scales the chart, the trader simply draws the three main Gann angles: the 1X2, 1X1 and 2X1 from main tops and bottoms. This technique frames the market, allowing the analyst to read the movement of the market inside this framework.

Uptrending angles provide the support and downtrending angles provide the resistance. Because the analyst knows where the angle is on the chart, he or she is able to determine whether to buy on support or sell at the resistance.

Traders should also note how the market rotates from angle to angle. This is known as the "rule of all angles". This rule states that when the market breaks one angle, it will move toward the next one.

Another way to determine the support and resistance is to combine angles and horizontal lines. For example, often a downtrending Gann angle will cross a 50%retracement level. This combination will then set up a key resistance point. The same can be said for uptrending angles crossing a 50% level. This area becomes a key support point. If you have a long-term chart, you will sometimes see many angles clustering at or near the same price. These are called price clusters. The more angles clustering in a zone, the more important the support or resistance. (For related reading, see Support & Resistance Basics.)

Gann Angles Determine Strength and Weakness

Source: TradeStation

The primary Gann angles are the 1X2, the 1X1 and the 2X1. The 1X2 means the angle is moving one unit of price for every two units of time. The 1X1 is moving one unit of price with one unit of time. Finally, the 2X1 moves two units of price with one unit of time. Using the same formula, angles can also be 1X8, 1X4, 4X1 and 8X1.

A proper chart scale is important to this type of analysis. Gann wanted the markets to have a square relationship so proper chart paper as well as a proper chart scale was important to his forecasting technique. Since his charts were "square", the 1X1 angle is often referred to as the 45-degree angle. But using degrees to draw the angle will only work if the chart is properly scaled.
Not only do the angles show support and resistance, but they also give the analyst a clue as to the strength of the market. Trading on or slightly above an uptrending 1X1 angle means that the market is balanced. When the market is trading on or slightly above an uptrending 2X1 angle, the market is in a strong uptrend. Trading at or near the 1X2 means the trend is not as strong. The strength of the market is reversed when looking at the market from the top down. Anything under the 1X1 is in a weak position. (For more insight, readGauging The Strength Of A Market Move.)

Gann Angles Can be Used for Timing

Source: TradeStation

Finally, Gann angles are also used to forecast important tops, bottoms and changes in trend. This is a mathematical technique known as squaring, which is used to determine time zones and when the market is likely to change direction. The basic concept is to expect a change in direction when the market has reached an equal unit of time and price up or down. This timing indicator works better on longer term charts, such as monthly or weekly charts; this is because the daily charts often have too many tops, bottoms and ranges to analyze. Like price action, these timing tools tend to work better when "clustered" with other time indicators.

ConclusionGann angles can be a valuable tool to the analyst or trader if used properly. Having an open mind and grasping the key concept that the past, present and future all exist at the same time on a Gann angle can help you analyze and trade a market with more accuracy. Learning the characteristics of the different markets in regard to volatility, price scale and how markets move within the Gann angle framework will help improve your analytical skills.

John W. Henry: Top Trader

Wisdom from John W. Henry:

I don’t believe that I am the only person who cannot predict future prices. No one consistently can predict anything, especially investors. Prices, not investors, predict the future. Despite this, investors hope or believe that they can predict the future, or someone else can. A lot of them look to you to predict what the next macroeconomic cycle will be. We rely on the fact that other investors are convinced that they can predict the future, and I believe that’s where our profits come from. I believe it’s that simple… when I was designing what turned out to be a trend following system…[that] approach–a mechanical and mathematical system–has not really changed at all. Yet the system continues to be successful today, even though there has been virtually no change to it over the last 18 years.

From The New Investment Superstars:

If one theme summarizes Henry’s philosophy, it is the knowledge that one cannot predict anything. Henry is a long-term follower. His philosophy is based on the premise that market prices, rather than market fundamentals, are the key aggregation of information needed to make investment decisions. He says, The markets are people’s expectations, and these expectations manifest themselves as price trends. We live in an uncertain world. One cannot predict the future of anything. In an uncertain world, identifying and following trends may be the only reasonable investment approach over the long term. Henry feels that a mechanical approach has more value since no scientific approach or solid testing can be applied to discretionary trading. Henry says that when he first researched the markets in the 1970s, he was looking for a methodology that would work through many market conditions. His research showed that long-term approaches work best over decades. There is an overwhelming desire to act in the face of adverse market moves. Usually it is termed ‘avoiding volatility’ with the assumption that volatility is bad. However, I found avoiding volatility really inhibits the ability to stay with the long-term trend. The desire to have close stops to preserve open trade equity has tremendous costs over decades. Long-term systems do not avoid volatility, they patiently sit through it. This reduces the occurrence of being forced out of a position that is in the middle of a long-term major move.

Q&A With John W. Henry

Q. How did you get started in money management, and what advice could you give to someone who would be interested in following in your footsteps?
A. How did I get started? I was hedging crops for farmland that I owned in a couple of states. I just seemed to do fairly well trading by the seat of my pants. It was a broker at Reynolds Securities in those days that asked me if I would manage money for farmers, because I seemed to do so well in the grain markets. That is sort of how it all started. I said no to hedging for farmers. I spent five years working on some ideas I had for trading, and one thing led to another. I came up with a [trend following] philosophy.

Larry Williams

Larry Williams is a well known commodities trader and author with materials dating back to the early eighties. In these past three decades he has written several best sellers and has secured his reputation as a trading expert.
There are several reasons why Larry Williams and his books have become so popular. He gained much credibility when a book that he published correctly predicted the upswing of the market at a time when the majority was forecasting a slowdown.
Moreover, Larry Williams shocked people in 1987 with his impressive results at the Robbins World Cup Trading Championship. Throughout the event Williams was able to turn $10,000 into a little more than one million dollars. To this day results like that haven’t been reported; supposedly this is why some have accused him of foul play at that tournament.
Larry Williams is also known for developing and teaching his own trading system. His methods have been called unconventional and at times risky. However, each trader should have their own system that is tailored to their financial situation, risk/loss threshold, and emotions.
His trading style does not rely heavily on charts so much as it does on indicators and timing tools that he has personally developed. These are known as the Williams %R and the Ultimate Oscillator.