- 1999: Volume 8, No. 2 Looking Into the Past to See the Future

"What has been, that will be; what has been done, that will be done. Nothing is new under the sun. Even the thing of which we say, 'See, this is new!' has already existed in the ages that preceded us." This passage from Ecclesiastics was a favorite of William D. Gann. His belief in history repeating itself was one of the cornerstones in his trading success during the early 1900s. His trading success is legendary even to this day.

Today thousands of traders and market analysts are hard at work trying to discover the Holy Grail. Using software that can be programmed to test every possible indicator or market scenario. Is there really a Holy Grail? That is the question that has driven traders for ages. Let us ask the question "What is technical analysis?" It is nothing but the study of the past and how it might relate to the future. Could this mean that all the systems hitting the market today are nothing but different variations of things already known? Are the highly touted trading systems great discoveries, or just a rehash of strategies used by the old masters with a few bells and whistles added? That is a lot to think about.

Today a trader cannot open a trading magazine or newspaper without seeing an ad for a highly profitable system. In recent years many systems have come and gone, with only a few withstanding the test of time. They all performed well in the computer testing period and boast profitable hypothetical track records to illustrate the profit potential. After purchasing these systems, many people experience problems and disappointment because people do not trade the same as a computer. The computer lacks the emotions of greed and fear. Everybody has a different risk tolerance. Some traders are not willing to take the same risk as the computer while others are happy with a different profit objective. You can have five traders following the same system and have five different results. So what happened? The people trading the systems did not get the same results they expected when they purchased the trading system, and soon become dissatisfied.

Now, is this because the system failed? No. The system was probably still generating the same signals as before, but now it has an unpredictable element added-the trader. Another factor to consider is that many trading systems work well in certain market conditions, but when those conditions change, the systems fail. When this happens the trader will go look for the next system with a good marketing budget or just leave the futures markets all together.

Trading systems have become a huge force in the futures market today, but are they a great breakthrough? Much of technical analysis today is just a repeat of discoveries introduced years ago by great trading masters such as Gann, Elliott, and Andrews. Some of the best methods have been around for years. Trading systems can be a good investment for some people, who like to rely on others to make their trading decisions or simply lack the time required to trade. However, this over dependence on a computer system is keeping people from learning the basics of trading. People are spending so much time testing ideas and systems, waiting for that one undiscovered trading technique, that they are missing the opportunity to learn about the markets and what they can tell a knowledgeable trader. To be a successful trader you should get back to the basics, learn the characteristics of the markets and chart action. I believe that most people want to learn to do this for themselves.

This generation, known as the Baby Boomers, seems to be a do-it-myself generation. The explosive growth of the online stock trading and now the online futures trading is a testimony to this growing phenomena. With the Internet, traders have more information and can access it faster than ever before. With all this high technology at their finger tips, the information is available to anyone interested in learning about the futures markets.

Ask a typical commodity futures trader how the markets work and he will tell you, without missing a beat, that it is all based on supply and demand. If demand for a particular commodity exceeds the supply, prices go up. If supply exceeds demand, then prices go down. It all seems so logical, unfortunately, it is not totally correct.

Yes, supply and demand play a key role, but not the one most people think. You see the simplistic law of supply and demand is constantly subjected to a force that is equally powerful, harder to measure, and infinitely less logical: human emotion. Because of two emotions that are as old as humanity itself-greed and fear-most traders have a tendency to overreact to market conditions. When things are going well, traders succumb to greed and overbuy in an effort to maximize profits. When the market seems to be not going their way, fear kicks in, causing a flurry of selling. These two market forces that have been around ever since the markets began and will always be a large factor. Supply and demand will change but human emotions remain a constant. The result of this market action produces clearly recognizable chart patterns I call "Reaction Swings."

Reaction Swings

Reaction Swings may not be as well known as flags, channels, or pennants, but they have an infinitely greater value as a forecasting tool, if one knows how to use them. Occurring in the center of the Reaction Cycle, these swings are the starting point for the "Reversal Day Indicator," which is used to identify future Reversal Days. Used properly these Reversal Days can pinpoint market turns with uncanny results. All traders know that reliable information about market turns is the key to consistent trading profits.

The Reversal Day Indicator, described in detail in the new book, A Traders Handbook-The Reversal Day Phenomenon, is based on the theory that for every action in the market there is an equal and opposite reaction. Reversal Days can easily be determined in any market with the right trading pattern; it only takes a few minutes. Sometimes these Reversal Days are part of a short-term or intermediate-term move that can generate modest, but rapid, market moves. And when the Reversal Days occur at important support or resistance levels, the potential can be astronomical.

How many times have you looked at a great idea and were amazed at its simplicity. That is what many people say when they learn about the Reversal Day Indicator. The Reversal Day Indicator is a simple concept combined with some old ideas. By looking into the past traders can see into the future. Let's look at some examples using the Reversal Day Indicator to identify market turns.

In July, 1998, the December S&P market began its collapse, causing many experts to predict gloom and doom for the market. (See figure 1.) In September the market made a short-lived correction before another sharp decline into October 8, 1998. On this day the market began a strong rally and made everybody happy again. Most people did not realize the S&P bottom was right on schedule, according to the Reversal Day Indicator. Five days before this bottom, a Reaction Cycle was confirmed. This would have allowed you to identify September 23, 1998 (A) as the Reaction Center. Just a quick measurement backwards, 19 days to be exact, identifies August 14, 1998 (B) as the beginning of the cycle. Now project forward, from the Reaction Center, the equal distance, 19 days exactly, and October 8th (C) marks the end of the Reaction Cycle, the exact day the December S&P posted a major low. Just luck? Not quite.

Figure 1

Figure 2

Now, let's look at an example that covers a much longer time scale. In 1997 coffee was making large price swings which in turn offered great opportunities to the trader with the right knowledge. Let's look how the Reversal Day Indicator could have helped. In late August, a Reaction Cycle could have been identified with August 13 (A) as the Reaction Center. Looking back to the low on July 21, 1997(B), the beginning of this Reaction Cycle, you can see that this low occurs 17 days before the Reaction Center. With this knowledge, you can now count forward from the Reaction Center to project the end of the Reaction Cycle. This suggests the market should turn on September 5, 1997, (C) and it did-right on schedule.

I want to take this example further to demonstrate how powerful the Reversal Day Indicator can be when properly identified. Using the same chart of the coffee market lets go further back to see if we can find a larger Reaction Cycle. Measuring back to the two highs on May 16 and May 29 (D), we have found a possible beginning of a larger Reaction Cycle. Using the same Reaction Center used before (A), measure forward the equal distance to identify timing for a major low in the coffee market that occurred between October 28 and November 7 (E). The market did post a major low, right on schedule!

Simple yet powerful! Improved timing on entry and exit of a trade position can enhance any trading approach. Computer testing and computerized trading systems may be the rage, but there is still a lot to learn from looking into the past. Any trader with knowledge of the Reversal Day Indicator can project market turns as powerful as the examples used. Every trader needs to spend time learning the market and price action-you will be surprised what the market can tell you.

John Crane is a partner in Traders Network, Inc., a Colorado brokerage firm. He is the author of The Trader's Handbook, and his research has appeared in numerous articles, from the Wall Street Journal and Stocks and Commodities to Barron's and Investor's Business Daily.