What Is A Gann Retracement?

A Gann retracement is essentially a correction in the price of a stock. Retracements occur when selling pressure from investors and traders taking profits causes an otherwise rising stock price to fall, bringing an overbought stock back down to a more reasonable level and providing the investor with the opportunity to add to the position at a lower price.

A retracement can be positive or negative as long as it is only a temporary setback in the prevailing trend. It differs from a reversal, which would indicate the end of a larger trend and the beginning of a new one.

For example, if a stock climbs from £10 to £30, then declines but remains well above the starting price of £10, the decline would be considered a retracement if the price subsequently resumed its upward trend. If the price continued to fall to the previous low of £10, it would be considered a reversal, as all previous gains have been lost.

The History Of The Retracement

Gann retracements are a key technical trading tool. They are named after W.D. Gann (1878 –1955), a trader who developed several technical analysis tools, including Gann angles. Gann theorised that in a perfect market, a stock price would move at a 45-degree angle either up or down with time; for example, one point per day. A steeper angle would mean that the stock is advancing too fast, while a flatter angle would mean that it is weakening and may be poised to decline.^[1]

Gann looked for important tops and bottoms on a chart and drew his angles from these changes in the trend. When the trend is up and the price stays above a rising angle without breaking below it, the market is considered strong; when the trend is down and the price remains below a descending angle without breaking above it, the market is weak.^[2]
The market's relative strength or weakness is thus measured by its angle above or below the line. If a retracement comes in contact with one of the Gann angle lines, a theoretical support has been detected and may signal whether the investor should be in the stock or not.

What Makes A Gann Retracement Different

A Gann angle differs from a trendline in that it moves at a uniform rate of speed. This enables the investor to estimate where the price is going to be on a particular date in the future. However, this does not mean that the Gann angle will actually predict where the price will be. Rather, it helps gauge the strength and direction of the trend. A trendline, by contrast, while it may have some predictive value, may be unreliable for making long-term forecasts.

When a retracement first begins, it is difficult to discern whether it is a simple correction or a reversal, because there is no time limit on when the retracement must conclude. Whether an investor identifies a change in a stock's direction as a retracement or a reversal will influence how one responds to it.

While a true downward reversal may indicate the stock should be sold in order to avoid losses, a retracement can actually signal a buying opportunity, because it allows the investor to purchase additional shares at a lower cost. The risk is that there is no guarantee that a retracement—and not a reversal—is occurring. As a result, these technical trading levels are not always reliable. However, they do provide good indications of when a change in market sentiment may be happening, allowing the investor to prepare a strategy.

As with all investment strategies, there are no assurances that a system used to predict a stock's direction will ultimately be correct.

Summary

A Gann retracement is a key technical trading tool that essentially signals a correction in the price of a stock. It was developed by W.D. Gann, who theorised that in a perfect market, a stock price would move at a 45-degree angle, either up or down, with time. Any deviation from that line could signal that a stock is advancing too fast, in which case it is poised for a downward correction, or is weakening and likely to decline further.

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