What is the Fan Principle?

As we have discussed, prices will tend to bounce back and forth between these trendlines. Many chartists believe that in order to confirm a trend reversal, the trendline must be broken three times. Look back on some of your own charts to see how uncannily accurate it is. 

In John Murphy’s Book, Technical Analysis Of The Futures Market (highly recommended reading, by the way), he talks about the importance of the number three. He says that the Fan Principle has three points, major bull and bear markets go through three phases, (Dow Theory and Elliott Wave Theory), there are three types of Gaps, there are Triple Tops and Triple Bottoms, Head and Shoulders that have three main peaks, three classes of trends that we talked about earlier, three trend directions (up, down and sideways), three types of triangles, and there are three principal sources of information— price, volume, and open interest. We will discuss all of these items later in the course. I just find it very interesting and did not want to forget to mention it.

45 Degree Angles

W.D. Gann liked to use 45-degree angles with all his trendline projections. His theory was that most “true” trendlines would angle at an almost perfect 45 degrees. If the angle is greater than or less than that, then it won’t hold. 

Look at the following chart to get an idea of what Mr. Gann was talking about.

So when you see a trendline that is just too slow, or too fast, don’t trust it in most cases. The trendline on the following chart was a perfect 45-degree angle and as you can see, it lasted for several months.

Remember this chart?  Look at the three lines I drew on it. As you can see, all three of them were approximately a 45-degree angle and they all lasted for two to three months. Aren’t these charts interesting? 

I do not personally hold much merit in this “rule” and just use my “eyeball” to see if it’s trending normally.