Wednesday, April 10, 2013

Alexander Elder Triple Screen Strategy

This is a Trend Strategy which uses a part of the "Third Screen Strategy" of Dr. Alexander Elder. First, I find in a D1 chart the global trend using the MACD indicator. Once the overall trend is clear, I use the H1 time frame to act in the same trend using the Williams Percentage Indicator. When the positions are opened I manage economic news and fundamental analysis to close the position if I think the trend is about to reverse on the D1 chart.

The above mentioned Trend Strategy is used in confluence with Price Action Support Resistance (PASR). Major areas of Support and Resistance are found using the Weekly and Monthly charts. It is important to observe Price Action (candle formation) at these significant S&R levels before placing a trade.



Triple Screen Trading System
A detailed description of this trading strategy

Sounding more like a medical diagnostic test, the triple screen trading system was developed by Dr. Alexander Elder way back in 1985. The medical allusion is no accident: Dr. Elder worked for many years as a psychiatrist in New York before becoming involved in financial trading. Since that time, he has written dozens of articles and books, including “Trading For A Living” (1993). He has also spoken at several major conferences.

Many traders adopt a single screen or indicator that they apply to each and every trade. In principle, there is nothing wrong with adopting and adhering to a single indicator for decision making. In fact, the discipline involved in maintaining a focus on a single measure is related to the personal discipline is, perhaps, one of the main determinant of achieving success as a trader. (See, Trading Psychology And Discipline.)

What if your chosen indicator is fundamentally flawed? What if conditions in the market change so that your single screen can no longer account for all of the eventualities operating outside of its measurement? The point is, because the market is very complex, even the most advanced indicators can't work all of the time and under every market condition. For example, in a market uptrend, trend-following indicators rise and issue “buy” signals while oscillators suggest that the market is overbought and issue “sell” signals. In downtrends, trend-following indicators suggest selling short, but oscillators become oversold and issue signals to buy. In a market moving strongly higher or lower, trend-following indicators are ideal, but they are prone to rapid and abrupt changes when markets trade in ranges. Within trading ranges, oscillators are the best choice, but when the markets begin to follow a trend, oscillators issue premature signals. (For more on oscillators, see Getting To Know Oscillators - Part 1, Part 2, Part 3 and Part 4.)

To determine a balance of indicator opinion, some traders have tried to average the buy and sell signals issued by various indicators. But there is an inherent flaw to this practice. If in the calculation of the number of trend-following indicators is greater than the number of oscillators used, then the result will naturally be skewed toward a trend-following result, and vice versa.

Dr. Elder developed a system to combat the problems of simple averaging while taking advantage of the best of both trend-following and oscillator techniques. Elder's system is meant to counteract the shortfalls of individual indicators at the same time as it serves to detect the market's inherent complexity. Like a triple screen marker in medical science, the triple screen trading system applies not one, not two, but three unique tests, or screens, to every trading decision, which form a combination of trend-following indicators and oscillators. (For more on indicators, see Economic Indicators To Know and Trading Psychology And Technical Indicators.)

The Problem of time frames There is, however, another problem with popular trend-following indicators that must be ironed out before they can be used. The same trend-following indicator may issue conflicting signals when applied to different time frames. For example, the same indicator may point to an uptrend in a daily chart and issue a sell signal and point to a downtrend in a weekly chart. The problem is magnified even further with intraday charts. On these short-term charts, trend-following indicators may fluctuate between buy and sell signals on an hourly or even more frequent basis.

In order to combat this problem, it is helpful to divide time frames into units of five. In dividing monthly charts into weekly charts, there are 4.5 weeks to a month. Moving from weekly charts to daily charts, there are exactly five trading days per week. Progressing one level further, from daily to hourly charts, there are between five to six hours in a trading day. For day traders, hourly charts can be reduced to 10-minute charts (denominator of six) and, finally, from 10-minute charts to two-minute charts (denominator of five).

The crux of this factor of five concept is that trading decisions should be analyzed in the context of at least two time frames. If you prefer to analyze your trading decisions using weekly charts, you should also employ monthly charts. If you day-trade using 10-minute charts, you should first analyze hourly charts.

Once the trader has decided on the time frame to use under the triple screen system, he or she labels this time frame as the intermediate time frame. The long-term time frame is one order of five longer; and the short-term time frame is one order of magnitude shorter. Traders who carry their trades for several days or weeks will use daily charts as their intermediate time frames. Their long-term time frames will be weekly charts; hourly charts will be their short-term time frame. Day traders who hold their positions for less than an hour will use a 10-minute chart as their intermediate time frame, an hourly chart as their long-term time frame, and a two-minute chart as a short-term time frame.

The triple screen trading system requires that the chart for the long-term trend be examined first. This ensures that the trade follows the tide of the long-term trend while allowing for entrance into trades at times when the market moves briefly against the trend. The best buying opportunities occur when a rising market makes a briefer decline; the best shorting opportunities are indicated when a falling market rallies briefly. When the monthly trend is upward, weekly declines represent buying opportunities. Hourly rallies provide opportunities to short when the daily trend is downward.

The stock market is generally thought to follow three trends, which market analysts have identified throughout history and can assume will continue in the future. These trends are as follows: the long-term trend lasting several years, the intermediate trend of several months, and the minor trend that is generally thought to be anything less than several months.

Robert Rhea, one of the market's first technical analysts, labeled these trends as tides (long-term trends), waves (intermediate-term trends) and ripples (short-term trends). Trading in the direction of the market tide is generally the best strategy. Waves offer opportunities to get in or out of trades, and ripples should usually be ignored. While the trading environment has become more complicated since these simplified concepts were articulated in the first half of the twentieth century, their fundamental basis remains true. Traders can continue to trade on the basis of tides, waves and ripples, but the time frames to which these illustrations apply should be refined. (To read more, check out Short-, Intermediate- And Long-Term Trends.)

Under the triple screen trading system, the time frame the trader wishes to target is labeled the intermediate time frame. The long-term time frame is one order of magnitude longer while the trader's short-term time frame is one order of magnitude shorter. If your comfort zone, or your intermediate time frame, calls for holding a position for several days or weeks, then you will concern yourself with the daily charts. Your long-term time frame will be one order of magnitude longer, and you will employ the weekly charts to begin your analysis. Your short-term time frame will be defined by the hourly charts.

If you are a day trader who holds a position for a matter of minutes or hours, you can employ the same principles. The intermediate time frame may be a ten-minute chart; an hourly chart corresponds to the long-term time frame, and a two-minute chart is the short-term time frame. (For further reading, see Day Trading: An Introduction.)

First Screen of the Triple Screen Trading System: Market Tide The triple screen trading system identifies the long-term chart, or the market tide, as the basis for making trading decision. Traders must begin by analyzing their long-term chart, which is one order of magnitude greater than the time frame that the trader plans to trade. If you would normally start by analyzing the daily charts, try to adapt your thinking to a time frame magnified by five, and embark on your trading analysis by examining the weekly charts instead.

Using trend-following indicators, you can then identify long-term trends. The long-term trend (market tide) is indicated by the slope of the weekly moving average convergence divergence (MACD) histogram, or the relationship between the two latest bars on the chart. When the slope of the MACD histogram is up, the bulls are in control, and the best trading decision is to enter into a long position. When the slope is down, the bears are in control, and you should be thinking about shorting. (To learn more, see Trading The MACD Divergence, Moving Average Convergence Divergence - Part 1 and Part 2.)

Any trend-following indicator that the trader prefers can realistically be used as the first screen of the triple screen trading system. Traders have often used the directional system as the first screen; or even a less complex indicator such as the slope of a 13-week exponential moving average can be employed. Regardless of the trend-following indicator that you opt to start with, the principles are the same: ensure that you analyze the trend using the weekly charts first and then look for ticks in the daily charts that move in the same direction as the weekly trend. (For more info, see Directional Movement - DMI and Basics Of Moving Averages.)

Of crucial importance in employing the market tide is developing your ability to identify the changing of a trend. A single uptick or a downtick of the chart (as in the example above, a single uptick or a downtick of the weekly MACD histogram) would be your means of identifying a long-term trend change. When the indicator turns up below its center line, the best market tide buy signals are given. When the indicator turns down from above its center line, the best sell signals are issued.

The model of seasons for illustrating market pricesfollows a concept developed by Martin Pring. Pring's model hails from a time when economic activity was based on agriculture: seeds were sown in spring, the harvest took place in summer and the fall was used to prepare for the cold spell in winter. In Pring’s model, traders use these parallels by preparing to buy in spring, sell in summer, short stocks in the fall and cover short positions in the winter.

Pring's model is applicable in the use of technical indicators. Indicator "seasons" allow you to determine exactly where you are in the market cycle and to buy when prices are low and short when they go higher. The exact season for any indicator is defined by its slope and its position above or below the center line. When the MACD histogram rises from below its center line, it is spring. When it rises above its center line, it is summer. When it falls from above its center line, it is autumn. When it falls below its center line, it is winter. Spring is the season for trading long, and fall is the best season for selling short.

Whether you prefer to illustrate your first screen of the triple screen trading system by using the ocean metaphor or the analogy of the changing of the seasons, the underlying principles remain the same.

A trader's chart is the foremost technical tool for making trading decisions with the triple screen trading system. For example, traders commonly use weekly moving average convergence divergence (MACD) histograms to ascertain their longer-term trend of interest. Deciding which stocks to trade on a daily basis, the trader looks for a single uptick or a downtick occurring on the weekly chart to identify a long-term change of trend. When an uptick occurs and the indicator turns up from below its center line, the best market tide buy signals are given. When the indicator turns down from above its center line, the best sell signals are issued.

By using the ocean metaphors that Robert Rhea developed (see Triple Screen Trading System - Part 2), we would label the daily market activity as a wave that goes against the longer-term weekly tide. When the weekly trend is up (uptick on the weekly chart), daily declines present buying opportunities. When the weekly trend is down (downtick on the weekly chart), daily rallies indicate shorting opportunities.

Second Screen – Market Wave Daily deviations from the longer-term weekly trend are indicated not by trend-following indicators (such as the MACD histogram), but by oscillators. By their nature, oscillators issue buy signals when the markets are in decline and sell signals when the markets are rising. The beauty of the triple screen trading system is that it allows traders to concentrate only on those daily signals that point in the direction of the weekly trend. (For further reading, see Getting To Know Oscillators - Part 1, Part 2 and Part 3.)

For example, when the weekly trend is up, the triple screen trading system considers only buy signals from daily oscillators and eliminates sell signals from the oscillators. When the weekly trend is down, triple screen ignores any buy signals from oscillators and displays only shorting signals. Four possible oscillators that can easily be incorporated into this system are force index, Elder-Ray index, stochastic and Williams %R. (For more detail, see Discovering The Force index - Part 1 and Part 2 and The Elder Ray Indicator: Seeing Into The Market.)

Force Index A two-day exponential moving average (EMA) of force index can be used in conjunction with the weekly MACD histogram. Indeed, the sensitivity of the two-day EMA of force index makes it most appropriate to combine with other indicators such as the MACD histogram. Specifically, when the two-day EMA of force index swings above its center line, it shows that bulls are stronger than bears. When the two-day EMA of force index falls below its center line, this indicator shows that the bears are stronger. (For further reading, see Digging Deeper Into Bull And Bear Markets.)

More specifically, traders should buy when a two-day EMA of force index turns negative during an uptrend. When the weekly MACD histogram indicates an upward trend, the best time to buy is during a momentary pullback, indicated by a negative turn of the two-day EMA of force index. When a two-day EMA of force index turns negative during a weekly uptrend (as indicated on the weekly MACD histogram), you should place a buy order above the high price of that particular day. If the uptrend is confirmed and prices rally, you will receive a stop order on the long side. If prices decline instead, your order will not be executed; however, you can then lower your buy order so it is within one tick of the high of the latest bar. Once the short-term trend reverses and your buy stop is triggered, you can further protect yourself with another stop below the low of the trade day or of the previous day, whichever low is lower. In a strong uptrend, your protective provision will not be triggered, but your trade will be exited early if the trend proves to be weak.

The same principles apply in reverse during a weekly downtrend. Traders should sell short when a two-day EMA of force index turns positive during the weekly downtrend. You may then place your order to sell short below the low of the latest price bar.

Similar in nature to the long position described above, the short position allows you to employ protective stops to guard your profits and avoid unnecessary losses. If the two-day EMA of force index continues to rally subsequent to the placement of your sell order, you can raise your sell order daily so it is within a single tick of the latest bar's low. When your short position is finally established by falling prices, you can then place a protective stop just above the high of the latest price bar or the previous bar if higher. (For further reading, see The Stop Loss Order - Make Sure You Use It.)

If your long or short positions have yet to be closed out, you can use a two-day EMA of force index to add to your positions. In a weekly uptrend, continue adding to longs whenever the force index turns negative; continually add to shorts in downtrends whenever the force index turns positive.

Further, the two-day EMA of force index will indicate the best time at which to close out a position. When trading on the basis of a longer-term weekly trend (as indicated by the weekly MACD histogram), the trader should exit a position only when the weekly trend changes or if there is a divergence between the two-day EMA of force index and the trend. When the divergence between two-day EMA of force index and price is bullish, a strong buy signal is issued. On this basis, a bullish divergence occurs when prices hit a new low but the force index makes a shallower bottom.

Sell signals are given by bearish divergences between two-day EMA of force index and price. A bearish divergence is realized when prices rally to a new high while the force index hits a lower secondary top.

The market wave is the second screen in the triple screen trading system, and the second screen is nicely illustrated by force index; however, others such as Elder-Ray, Stochastic, and Williams %R can also be employed as oscillators for the market wave screen.

The triple screen trading system is based on employing the best of both the trend-following indicators and oscillators to make trading decisions. Traders are primarily concerned with any realized divergences between the readings of a longer-term trend-following indicator such as a weekly moving average convergence divergence (MACD) histogram and the relatively shorter-term reading from an oscillator such as force index, Elder-Ray, stochastic, or Williams %R.

The fourth section of this series, will examine the means by which a trader would use the Elder-Ray oscillator as the market wave, which is the second screen of the trader's triple screen system. (For further reading, see Triple Screen Trading System - Part 3 and The Elder Ray Indicator: Seeing Into The Market.)

Second Screen - Elder-Ray Elder-Ray, devised by Dr. Alexander Elder, is based on the concepts of bull power and bear power, the relative strength of bulls and bears in the market. Bull power measures the ability of market bulls to push prices above the average consensus of value, which is the actual price at which a particular stock happens to be trading for a given point in time. Bear power is the bears' ability to drive prices lower than current prices, or the current average consensus of value. (See Trading Psychology And Technical Indicators.) By using a longer-term trend-following indicator, perhaps a weekly MACD histogram, traders can identify the direction of the longer-term trend. Bull power and bear power are then used to find trades on the daily charts that move in the same direction as the weekly trend. The triple screen earns its "screening" label because it eliminates all signals but those in the direction of the trend: if the weekly trend is up, only buy signals are returned from Elder-Ray. If the weekly trend is down, only Elder-Ray sell signals are considered.

Buy Signals There are two absolutely essential conditions that need to be in place for traders to consider buying: 1) the weekly trend should be up, and 2) bear power, as represented on Elder-Ray, should be negative but rising. The second condition - negative bear power - is worth exploring. The opposite condition, in which bear power is positive, occurs in a runaway uptrend, a dangerous market environment for trading despite the apparent strength of the trend. The problem with buying in a runaway uptrend is that you are betting on the greater fool theory, which states that your profit will be realized only by eventually selling to somebody willing to pay an even higher price.

When bear power is negative but rising, bears are showing a bit of strength but are beginning to slip once again. By placing a buy order above the high of the last two days, your stop order will be filled only if the rally continues. Once you have gone long, you can protect your position with a stop below the latest minor low. Bullish divergences between bear power and price (average consensus of value) represent the strongest buy signals. If prices fall to a new low but bear power shows a higher bottom, prices are falling and bears become weaker. When bear power moves up from this second bottom, you can comfortably buy a larger number of shares than you typically would in your usual position. (See Getting Confirmation With The Momentum Strategy and Momentum Trading With Discipline.)

You can also use Elder-Ray to determine the best time to sell your position. By tracking the pattern of peaks and valleys in bull power, you can ascertain the power of bulls. By stacking the peaks in actual price against the peaks in bull power, you can determine the strength of the uptrend - if every new peak in price comes along with a new peak in bull power, the uptrend is safe. When prices reach a new high but bull power reaches a lower peak than that of its previous rally, the bulls are losing their power and a sell signal is issued. (For more info, see Peak-And-Trough Analysis.)

Shorting Elder-Ray as the second screen in the triple screen trading system can also be used to determine the conditions in which shorting is appropriate. The two essential conditions for shorting are 1) the trend is down and 2) bull power is positive but falling. (For further reading, check out Short Selling Tutorial.)

If bull power is already negative, selling short is inappropriate because bears have control over the market bulls. If you short sell in this condition, you are effectively betting that bears have sufficient strength to push bulls even farther under water. Furthermore, as in the case discussed above, wherein the trader holds a long position during positive bear power, you are betting on the greater fool theory. When bull power is positive but falling, the bulls have managed to grasp a bit of strength but are beginning to sink once again. If you place a short order below the low of the last two days, you receive an order execution only if the decline continues. You can then place a protective stop above the latest minor high.

Bearish divergences between bull power and prices (average consensus of value) give the strongest shorting signals. If prices hit a new high but bull power hits a lower top, the bulls are weaker than before, and the uptrend may not continue. When bull power inches down from a lower top, you can safely sell short a larger-than-usual position.

You can also determine when to cover your short positions on the basis of a reading of Elder-Ray. When your longer-term trend is down, bear power will indicate whether bears are becoming stronger or weaker. If a new low in price occurs simultaneously with a new low in bear power, the current downtrend is relatively secure.

A bullish divergence issues a signal to cover your shorts and prepare to enter into a long position. Bullish divergences occur when prices hit a new low and bear power hits an even shallower bottom, when bears are losing their momentum and prices are falling slowly.

For both long and short positions, divergences between bull power, bear power and prices indicate the best trading opportunities. In the context of the long-term trend indicated by our first market screen, Elder-Ray identifies the moment when the market's dominant group falters below the surface of the trend. For the second screen of the triple screen trading system, Dr. Alexander Elder recommends the use of sophisticated and modern oscillators like force index and Elder-Ray. However, traders should not feel limited to either of these two oscillators - your favorite oscillator will probably work equally well, so you should substitute the oscillator with which you feel most comfortable. Two other oscillators that can easily be employed as the second screen are the stochastic and Williams %R oscillators.

Stochastic Stochastic is currently one of the more popular oscillators and is included in many widely available software programs used both by individual traders and professionals. In particular, traders who employ strict computerized systems to execute their trades find that stochastic oscillators have many good qualities. For example, stochastic has an excellent track record in weeding out bad signals. More specifically, stochastic uses several steps for the express purpose of filtering out market noise, the type of ultra short-term movements that do not relate to the trader's current trend of interest.

Similarly to Elder-Ray, stochastic identifies the precise moment at which bulls or bears are becoming stronger or weaker. Obviously, traders are best off jumping aboard the strongest train and trading with the winners while pitting themselves directly against the losers. The three types of signals important to traders using stochastic are divergences, the level of the stochastic lines and the direction of the stochastic lines. (To further detail, see Getting To Know Oscillators - Part 3: Stochastics and What is the difference between fast and slow stochastics in technical analysis?)

Divergences A bullish divergence occurs when prices hit a new low but stochastic traces a higher bottom than it did in the previous decline. This means the bears are losing their grip on the market and simple inertia is driving prices lower. A very strong buy signal is issued as soon as stochastic turns up from its second bottom. Traders are well advised to enter into a long position and place a protective stop below the latest low in the market. The strongest buy signals appear when the stochastic line's first bottom is placed below the lower reference line and the second bottom above it.

Conversely, a bearish divergence corresponds to the circumstance in which prices rally to a new high but stochastic reaches a lower top than anytime during its previous rally. Bulls are then becoming weaker and prices are rising sluggishly. The crucial sell signal is issued when stochastic turns down from its second top. Traders should enter a short position and place a protective stop above the latest price high. The best signals to sell short occur when the first top is above the upper reference line and the second is below it, the opposite of the best signals to go long. (To learn more, check out Divergences, Momentum And Rate Of Change and Moving Average Convergence Divergence - Part 1 and Part 2.)

Level of Stochastic Lines The level attained by the stochastic lines represents distinct overbought or oversold conditions. When stochastic rallies above the upper reference line, the market is said to be overbought and is ready to turn downwards. By contrast, the oversold condition, in which the market is ready to turn up, is represented by the stochastic falling below its lower reference line.

Traders should, however, be careful in interpreting overbought and oversold conditions using stochastic: during a longer-term trend, stochastic may issue contrary signals. In strong uptrends - as may be indicated by the trader's first market screen - the moving average convergence divergence (MACD) histogram, stochastic becomes overbought and issues erroneous sell signals while the market rallies. In downtrends, stochastic quickly becomes oversold and gives buy signals earlier than warranted.

Although interpreting overbought and oversold conditions with stochastics can be problematic, when using the MACD histogram as the first screen of the triple screen trading system, traders can easily eliminate these incorrect signals. Traders should take buy signals from the daily stochastic only when the weekly MACD histogram shows an upward trend. When the trend is down, only sell signals from the daily stochastic should be heeded.

Using your weekly chart to identify an uptrend, wait for daily stochastic lines to cross below their lower reference line before buying. Immediately place your buy order above the high of the latest price bar. You can then protect your position with a protective stop placed below the low of the trade day or the low of the previous day, whichever is lower.

To add a further level of detail to this analysis, how the shape of stochastic's bottom can indicate the relative strength of the rally should be discussed. If the bottom is narrow and shallow, the bears are weak and the rally is likely to be strong. If the bottom is deep and wide, the bears are strong and the rally could very well be weak.

When you identify a downtrend on your weekly chart, do not enter your trade until daily stochastic lines rally above their upper reference line. You can then immediately place an order to sell short below the low of the latest price bar. Do not, however, wait for a crossover on the stochastic lines as the market will then already likely be in a free fall. To protect your short position, place a protective stop above the high of that particular trading day or the previous day, whichever is higher.

The shape of stochastic's top can also indicate the relative steepness or sluggishness of the market's decline. A narrow top in the stochastic line shows the weakness of bulls and the likelihood of a severe decline. A high and wide stochastic top demonstrates the strength of bulls, and short positions should consequently be avoided.

In summary, the means by which traders can filter out most bad trades involves an intimate knowledge of overbought and oversold conditions. When stochastic is overbought, do not buy. When stochastic is oversold, do not sell short.

Stochastic Line Direction Quite simply, when both of the stochastic lines are moving in the same direction, the short-term trend is confirmed. When prices rise along with both stochastic lines, the uptrend is most likely to continue. When prices slide along while both stochastic lines are falling, the short-term downtrend will likely continue.

When employed correctly, stochastic can be an extremely effective and useful oscillator as part of your triple screen trading system. In Part 6 of this article, we'll examine the fourth oscillator of interest, Williams %R.

In previous parts to this series on Dr. Alexander Elder's triple screen trading system, various oscillators have been discussed in relation to the second screen of the system. Two excellent oscillators that work extremely well within the system are force index and Elder-Ray; however, any other oscillators may also be employed. Part 5 of this series described stochastic in relation to the powerful signals formed by divergences between the power of bulls and bears in the market. In this section, we’ll discuss one final oscillator that can be used as the second screen in the triple screen trading system: Williams %R.

Williams %R The final oscillator that needs consideration in relation to its use as the second screen of the triple screen trading system is Williams %R, which is actually interpreted in similar fashion to that of stochastic. Williams %R, or Wm%R, measures the capacity of bulls and bears to close the day's stock prices at or near the edge of the recent range. Wm%R confirms the strength of trends and warns of possible upcoming reversals.

The actual calculation of Wm%R will not be dissected in detail in this space, as its current value can be obtained through top trading software packages that are widely available today. In its calculation, Wm%R measures the placement of the latest closing price in relation to a recent high-low range. It is important to note that Wm%R requires at least a four- to five-day range of prices to work effectively with the triple screen trading system.

Wm%R expresses the distance from the highest high within its range to the lowest low in relation to a 100% scale. The distance from the latest closing price to the top of the range is expressed as a percentage of the total range. When Wm%R is equal to 0% on the 100% scale, the bulls reach the peak of their power and prices should close at the top of the range. In other words, a zero reading, plotted at the top of the chart, indicates maximum bull power. When Wm%R reads 100, the bears are at the peak of their power and they are able to close prices at the bottom of the recent range.

The high of the range is a precise measure of the maximum power of bulls during the period in question. The low of the range relates to the maximum power of bears during the period. Closing prices are especially significant in calculating Wm%R, as the daily settlement of trading accounts depends on the day's (or week's, or month's) close. Wm%R provides a precise assessment of the balance of power between bulls and bears at the market close, the most crucial time for a true feel for the relative bullishness or bearishness of the market.

If we extrapolate this concept one level further, we see that Wm%R shows which group is able to close the market in its favor. If the bulls cannot quite close the market at or near the top during a market rally, the bulls are proven to be somewhat weaker than they appear. If bears cannot close the market near the lows during a bear market, they are weaker than they would appear on the surface. This situation presents a buying opportunity.

If reference lines are drawn horizontally at 10% and 90% levels, this further refines the Wm%R interpretation. When Wm% closes above its upper reference line, the bulls are strong, but the market is said to be overbought. When Wm%R closes below the lower reference line, the bears are strong but the market is oversold. (For additional insight, see Market Reversals And How To Spot Them and Price Patterns - Part 1.)

Overbought and Oversold In an overbought condition, Wm%R rises above its upper reference line and prices close near the upper edge of their range. This may indicate a market top, and the Wm%R issues a sell signal. In an oversold condition, Wm%R falls below its lower reference line and prices close near the bottom of their range. This may indicate a market bottom, and the Wm%R issues a buy signal. During flat trading ranges, overbought and oversold signals work very well. However, when the market enters a trend, using overbought and oversold signals may be dangerous. Wm%R can remain near the top of its range for a week or longer during a strong rally. This overbought reading may actually represent market strength rather than the erroneous shorting signal that Wm%R would issue in this circumstance. Conversely, in a strong downtrend, Wm%R can remain in oversold territory for a long period of time, thereby demonstrating weakness rather than a buying opportunity.

For these reasons, overbought and oversold readings of Wm%R should be used only after you have identified the major trend. This is where the first screen in the triple screen trading system is absolutely essential. You must use that first screen to ascertain whether you are currently embroiled in a longer-term bull or a bear market. (For refresher on the first screen, check out Triple Screen Trading System - Part 1.)

If your longer-term chart shows a bull market, take buy signals only from your shorter-term Wm%R, and do not enter a short position when it gives a sell signal. If your weekly chart indicates a bear market, sell short only when Wm%R gives you a sell signal, but do not go long when Wm%R becomes oversold.

Failure Swings When Wm%R fails to rise above its upper reference line during a rally and turns down in the middle of that rally, a failure swing occurs: bulls are especially weak, and a sell signal is issued. When Wm%R stops falling in the middle of the decline, failing to reach the lower reference line and turning up instead, the opposite failure swing occurs: the bears are very weak and a buy signal is issued. (For further insight, see The Dead Cat Bounce: A Bear In Bull’s Clothing? and Short-, Intermediate- and Long-Term Trends and Relative Strength Index And Its Failure-Swing Points.)

Divergences The final important situation in reading Wm%R relates to divergences between prices and Wm%R. Divergences rarely occur, but they identify the absolute best trading opportunities. A bearish divergence occurs when Wm%R rises above its upper reference line, then falls and cannot rise above the upper line during the next rally. This shows that bulls are losing their power, that the market is likely to fall and that you should sell short and place a protective stop above the recent price high.

By contrast, a bullish divergence occurs when Wm%R falls below its lower reference line, then moves up (rallies), and cannot decline below that particular line when prices slide the next time around. In a bullish divergence, traders should go long and place a protective stop below the recent price low. (To learn more, see The Stop-Loss Order - Make Sure You Use It and A Look At Exit Strategies.)

At long last, the next part of this series on the triple screen trading system will provide a discussion of the third screen in the system. The first screen of the system identifies a market tide; the second screen (the oscillator) identifies a wave that goes against the tide. The third and final screen of the triple screen system identifies the ripples in the direction of the tide. These are intraday price movements that pinpoint entry points for your buy or sell orders.

The triple screen trading system can be nicely illustrated with an ocean metaphor. The first screen of the triple screen trading system takes a longer-term perspective and illustrates the market tide. The second screen, represented by an oscillator, identifies the medium-term wave that goes against the tide. The third screen refines the system to its shortest-term measure, identifying the ripples that move in the direction of the tide. These are the short-term intraday price movements that pinpoint entry points for your buy or sell orders during the trading day. (If you need a refresher, check out Triple Screen Trading System - Part 1, Part 2 and Part 3.)

Fortunately, for those of us who have become weary of interpreting charts or technical indicators in the first and second screen, the third screen does not require any additional technical talent. Instead, the third screen provides us with a technique for placing stop orders, either buy stop orders or sell stop orders, depending on whether the first and second screens direct you to buy or to sell short.

More specifically, the third screen is called a trailing buy stop technique in uptrends and a trailing sell stop technique in downtrends. When the weekly trend is up (identified by the first screen) and the daily trend is down (identified by the second screen, or oscillator), placing a trailing buy stop will catch upside breakouts. When the weekly trend is down and the daily trend is up, trailing sell stops catch downside breakouts. Each situation deserves further examination.

Trailing Buy Stop Technique When you have identified that a longer-term (weekly) trend is moving up and your medium-term (daily) oscillator declines, the triple screen trading system activates a trailing buy stop technique. To instigate the trailing buy stop technique, place a buy order one tick above the high of the previous day. Then, if prices rally, you will be stopped into a long position automatically at the time that the rally exceeds the previous day's high. If, however, prices continue to decline, your buy stop order will not be touched.

This technique allows you to be stopped into your order if the shortest-term ripples have sufficient momentum to power the wave into the greater tide. The buy stop is therefore most closely related to what most traders would label as momentum investing. However, the use of all three screens within the triple screen trading system provides a much more detailed and refined picture of the market than the simple concept of momentum generally provides. (For further reading, see Momentum Trading With Discipline and Introduction To Types Of Trading: Momentum Traders.)

If you want to further refine the trailing buy stop technique, you can lower your buy order the next day to the level one tick above the latest price bar. Keep lowering your buy stop each day until stopped out (filling your order at the very best time!) or until your long-term (weekly) indicator reverses and cancels its buy signal (saving you from a loss!). The reason that the buy stop technique is prefaced by the trailing qualification relates to this fluid nature of the buy stop order. You must, however, remain vigilant in monitoring the market's momentum, and you must be diligent in continually moving your buy stop to one tick above the latest price bar. The process can be laborious, but it will ensure that you either fill your order at the very best price or avoid a poor trade altogether if the market fails to move your way. (To read more, check out Trailing Stop Techniques and The Stop-Loss Order - Make Sure You Use It.)

Trailing Sell Stop Technique The opposite situation occurs when your long-term (weekly) trend is down, at which time you would wait for a rally in your medium-term indicator (oscillator) to activate a trailing sell stop technique. In the trailing sell stop technique, you place an order to sell short one tick below the latest bar's low. When the market turns down, you will automatically be stopped into your short trade.

If, however, the market continues to rally, you can continue to raise your sell order on a daily basis. Opposite to the trailing buy stop technique, the trailing sell stop technique is meant to catch an intraday downside breakout from a daily uptrend. As you can see, the intraday downside breakout moves in the direction of the market tide, which in this case is a weekly downtrend.

The trailing buy stop and trailing sell stop techniques are the ultimate refinements to what is already an extremely powerful trading system within the first two screens of the three screens. Using a less developed indicator, many beginning traders will engage in a system of trailing stopped orders when they attempt to gauge market momentum. By employing a longer-term chart and a medium-term oscillator first, you can capitalize on the short-term market ripples as you make the best trades that this intraday allows.

The next section of this series will bring the triple screen trading system to a close. The journey through all three screens has been long, but the result is most definitely worthwhile. If you are able successfully to implement the triple screen trading system to its fullest, you are on your way to being ahead many other trader with whom you are competing for profits!

At long last, we have reached the end of this series describing all facets of the triple screen trading system. You will recall that the third screen in the system, the trailing buy or sell stop system, allows for the ultimate level of precision in your buy orders or, if you are selling short, your sell orders. By identifying the ripples moving in the direction of the market tide, you will best be able to capitalize on the short-term (usually intraday) price movements that pinpoint the exact points at which you should enter your position. (To brush up on previous sections, see Triple Screen Trading System - Part 1, Part 2, Part 3, Part 4, Part 5, Part 6 and Part 7.)

Stop loss Technique But we have yet to discuss how the triple screen trading system assists a trader, once in a position, to secure a profit and avoid significant losses. As is the case in all levels of trading, and investing at large, the decision to exit your position, whether long or short, is just as important as your decision to enter a position. The triple screen trading system ensures that you make use of the tightest stops, both in entering and in exiting your position.

Immediately after executing your purchase order for a long position, you place a stop loss order one tick below the low of the trade day or the previous day, whichever is lower. The same principle applies to a short sale. As soon as you have sold short, place a protective stop loss one tick above the high of the trade day or the previous day, whichever is highest.

In order to protect against the potential for losses, move your stop to a breakeven level as soon as the market moves in your favor. Assuming that the market continues to move you into a position of profits, you must then place another protective stop at your desired level of profits. Under this system, a 50% profit level is a valid rule of thumb for your targeted profitability.

The Importance of Stop Loss The stop loss orders used in exiting a position are very tight under this system because of the fundamental tide of the market. If you enter into a position using the analysis tools contained in the triple screen trading system only to see the market immediately move against you, the market has likely undergone a fundamental shift in tide. Even when identifying the market's probable long-term trend in the first screen, you can still be unlucky enough to enter your trade, for which you use the third screen, at the very moment at which the long-term trend is changing. Although the triple screen system can never identify this condition organically, the trader can prevent losses by keeping his or her stop loss extremely tight. (For further reading, see The Stop-Loss Order - Make Sure You Use It, A Look At Exit Strategies and Can a stop-loss order be used to protect a short sale transaction?)

Even if your position enters into the red, it is always better to exit early and take your loss sooner rather than later. Realize your small loss, then sit back, and observe what is happening in the market. You will likely be able to learn something from the experience: if the market truly has shifted its long-term direction, you might better be able to identify the situation should it happen again in the future.

Conservative and Aggressive Exit Strategies The above discussion has outlined a relatively conservative strategy for risk-averse traders. By maintaining the tightest stop loss orders possible, conservative traders can easily go long or short on the first strong signal from the triple screen trading system and stay with that position for as long as the major trend lasts. Once the trend reverses, the profits will already be locked in. If the market reverses prematurely, the trader will be stopped out of major losses.

A possibility for more aggressive, active traders is to continue watching the market after entering into a long or short position. While the longest-term trend is still valid, active traders can use each new signal from the second screen (the daily oscillator) to supplement the original position. This approach allows for a greater level of gross profit while still allowing the stop loss approach to protect the entire position. Adding to the original position while the trend continues is often referred to as pyramiding the original position. Another type of trading is practiced by the position trader, who should try to go long or short on the very first signal issued by the triple screen system. Then he or she should stay with that position until the trend reverses.

Finally, a short-term trader may take profits using signals from the second screen. You may recall that the second screen identifies the medium-term wave that goes against the larger tide. Using the very same second screen indicator that is used prior to entering the trade, the short-term trader can use intraday occurrences of market reversals to exit the trade. If, for example, the short-term trader uses stochastic as his or her second screen oscillator, he or she may sell the entire position and take the profits when stochastic rises to 70%. The trader can then revisit the first screen of the system, reconfirm the market tide and continue to drill down to the second and third screens in order to identify another buying (or selling) opportunity.

Conclusion The length of this eight-part series demonstrates that Dr. Alexander Elder's triple screen trading system is not the simplest means of identifying buying and selling opportunities on the markets. The system is, however, one of the most powerful means of combining a series of useful individual indicators into one comprehensive whole. The time that you spend reading these articles and familiarizing yourself with the individual components of the system will undoubtedly pay dividends to your trading success.        
      

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