Beginners often look for a magic tool – a signal indicator that could help them to earn piles of money. If they get lucky for a while, they think that they’ve discovered the road to Eldorado. But, when the magic dies, and these amateurs start losing money, they give up on their old playfellow and start hunting for another goldmine. Well, I won’t discover America, if I tell you that it’s wrong. The markets are too complex to be analyzed with a single indicator. And, as soon as you read the latter sentence, you will probably say: “Well, ok, I tried to use different indicators, but they give me contradictory signals”. And you will be absolutely right; indicators like wrangling with each other and give traders false buy/sell signals.
To help you to grapple with this confusing situation, Alexander Elder, one of the brightest men of traders’ society, invented a so-called triple screen trading system. It combines the trend-following indicators with oscillators and filters out their disadvantages while preserving their strengths. Genius, told you!
Like a triple screen marker in medical science (before getting involved in financial trading, Elder worked as a psychiatrist, by the way), the triple screen trading system applies several unique tests, or screens, to every trading decision. Thereby it minimizes your risks and offers you more profits.
How does this system work?
First, you should decide which timeframe you want to trade. There are three main trends – long-term, intermediate and minor. Robert Rhea, the prominent market technician of the 1930s, compared these market trends to a tide, a wave, and a ripple accordingly. He believed that traders have to trade in the direction of the market tide (which could be identified on the first screen of a larger time frame), take advantage of the waves (which indicate intermediate changes in trading patterns) and keep an eye on the ripples (don’t ignore the minor trade signals displayed on the third screen).
For example, if you want to trade for several days, then your intermediate timeframe will be defined by the daily charts. Weekly charts will help you to determine long-lasting trends (tides), and hourly charts will shield you from minor fluctuations within the upward/downward trade channel.
Once you defined your timeframes, you can plunge into unraveling the trade patterns. Start with analyzing the long-term chart to define the dominant trend with the help of trend-following indicators. Look at the slope of MACD-Histogram, when it is up – bulls control the market. And, conversely, when the slope is down, it shows that bears are in control which means that you should trade only from the short side. A single upswing or downswing of weekly MACD Histogram tells us about the change of the trend. The upturns that occur below the center line give better buy signals than those that lie above the centerline (because here we observe the very “birth” of the upward trend). The downturns which occurs above the centerline give better sell signal than the downturns below the centerline. Off course, you can use a simpler tool to identify the trend – an exponential moving average, for example. It’s up to you.
The Second Screen helps us to identify the waves that go against the tide (the weekly trend may go up, while the daily trend may decline and indicate buying opportunities, and vice versa). And here, on the second screen, oscillators come into play, they should be used to define these deviations from the weekly trend. Oscillators give buy signals when market decline and sell signals when market rise. And your task is to find only those daily signals that point in the direction of the dominant weekly trend.
For example, if the weekly trend is rising, you should take into consideration only buy signals from daily oscillators and ignore their sell signals. To do so you can use Force Index and the 2-day EMA oscillators. Stochastic oscillator also performs well. It gives trading signals when its line enters a buy or a sell zone. When weekly MACD rises, but daily Stochastic falls below 30, it identifies the oversold area (a buy signal). Alternatively, when the weekly MACD declines, but Stochastic rises above 70, it identifies an overbought area (a sell signal).
The third screen is used to identify so-called ripples which go against the dominant trend. It uses intraday price action to pinpoint entry points. The third screen doesn’t require any technical tools. It helps to enter the market once the first and second screens gave a signal to buy or sell short. It is a trailing technique used to warn when you should to stop buying in uptrends, or stop selling in downtrends.
For example, when the weekly trend is up and the daily trend is down, trailing buy-stops catch upside breakouts. When the weekly trend is down and the daily one is up, trailing sell-stops catch downside breakouts.
When the weekly trend is up and a daily oscillator declines, you’d better to activate a trailing buy-stop technique. Place a buy order one tick above the high of the previous day. If prices continue to rise, you will be automatically stopped when they reach the mark of the previous day’s high. If prices continue to fall, your buy-stop won’t be activated. The next day you should lower your order to the level one tick above the latest price candle. You should continue to do so every day until the weekly indicators shows another trend. The same tactics should be applied when the dominant trend is falling. The daily oscillator should go up, and then you activate a trailing sell-stop technique. You should place an order to sell short one tick below the latest candle’s low. If the market decides to change its direction, you will be protected from losses with the help of a trailing sell-stop technique. Change its location every day until the weekly trend changes its direction.
By using the Elder’s strategy described in this article, you will be well-protected from the risks of losing money (the risk of being deceived by the false trading signals) and, at the same time, you will be able to earn more (with help of indicators and oscillators you won’t miss your profits).