Rule No.4: Buy and Sell on 3 Weeks Advance or Decline
Markets do not go up forever! There must be some profit taking involved along the way. In Gann's rule, he said "buy when the market is decline for 3 weeks in a bull trend". What this means is that when the market is up for about 2-3 months, there'll be a correction, this correction usually takes in the form of 1-3 weeks decline, after which the bull trend resumes. So to apply this rule, we have to wait for the market to decline for 3 weeks, then start buying, but remember to put a stop loss should the decline extend further. If the market only decline for 1 week, no entry. Similarly, in a bear market, markets do not fall forever, after a few months of decline, there will be a pull back. In Gann's rule, sell after 3 weeks of bear rally.
Chart 1: KLCI 2010
The above chart 1 illustrate this perfectly well on our KLCI in the year of 2010. The 3 sell down in the month of Feb, May and Nov lasted about 3 weeks or 15 days (1 week = 5 trading days).
Next, Gann said, "after the market advance or decline 30 days or more, the next buy or sell point is 6 or 7 weeks. And after a market rallies or declines more than 45 to 49 days, the next time period to watch is 60 to 65 days."
To illustrate his statement, let's take a look at the chart below: Chart 2 KLCI 2011
In the first half of 2011, news on the euro debt crisis causing the market to react negatively. Between mid January to mid March, the sell down lasted about 7 weeks, which is 36 days in exact. In addition, in the second half of 2011, the US debt ceiling crisis resulted in stock market crashes around the world. KLCI reacted with a sell down for 60 days! After which the long term bull trend resumed.
Now, the question is how do we know what's the duration of the decline? We do not know, we just need to keep our stop loss at bay to protect ourselves.
Chart 3 KLCI 2012
Recently in November 2012, we had exactly 16 black candles, that was unusual as it was consecutively black candles with no white candle in the middle. However, 16 days is close to the 3 weeks of Gann's rule, so the rule still applied for this case.
Rule No.5: Market Moves in Sections
Market moves in sections or waves. Usually for a bull market, you will see 3 or 4 up waves before you can consider the top.
Similarly, in a bear market, never consider the market final bottom when you see the first decline wave because it will run 3 or possibly 4 sections before the bear campaign is over.
Chart 4 KLCI 2006 - present
From the chart above, we are currently on the 3rd wave. We do not know how long this wave will last, or there could be a 4th wave. Only time will tell. My advice for long term investors is to use the 200 day Moving Average as a reference, sell when your stock falls below this line, and get back in once it is above the line again.