The trades to avoid (the Impulse system)
Before we build a trading system let’s set up a censorship system. The Impulse system will keep us out of trouble by showing when not to trade. As Jesse Livermore, one of the great speculators of the 20th century, said to an interviewer: “There’s a time to be long, a time to be short, and a time to go fishing.”
The Impulse System applies a pair of indicators to any trading vehicle or an index: a fast exponential moving average and MACD-Histogram. The slope of the EMA reflects the direction of the market’s inertia. The slope of the last two bars of MACD-Histogram shows the direction of market power. Their combination colors every bar: green if both are rising, red if both are falling, and blue if they move in the opposite directions. When both the inertia and the power are pointing against your planned trade, you shouldn’t be getting into it.
* EMA rising & MACD-Histogram rising (especially below zero) = Impulse is green, bullish. Shorting is prohibited, buying or standing aside is permitted.
* EMA falling & MACD-Histogram falling (especially above zero) = Impulse is red, bearish. Buying is prohibited, shorting or standing aside is permitted.
* EMA rising & MACD-Histogram falling = Impulse is blue, neutral. Nothing is prohibited.
* EMA falling & MACD-Histogram rising = Impulse is blue, neutral. Nothing is prohibited.
When both indicators decline, showing that bears are in charge, they prohibit buying. When both rise, showing that bulls are in charge, they prohibit shorting. We need to check the colors of the Impulse system in two timeframes – our favorite (tactical, usually daily chart) and the chart one order of magnitude longer (strategic, usually weekly chart). If even one of them says ‘no’ to our trade, we should stand aside and wait for the Impulse system to release us to trade.
As for the indicator parameters, we can use a 13-bar EMA and a 12-26-9 MACD-Histogram. You may change these parameters, just be sure to use the same numbers consistently.
The Impulse system doesn’t mean “buy green, sell red,” as some copy-cats cheerfully until the Impulse turns green, you’ll miss the best opportunities. Our goal is to identify a potential buy early, while the Impulse system is still red, and then closely monitor that stock. As soon as the Impulse changes from red to blue, it removes its prohibition of buying and releases us to buy. Its best signals are given not by color (green or red), but by the disappearance of color (the Impulse stops being red or green and turns blue).
Silica Holdings Inc. (SLCA) serves oil producers in the Canadian tar sands as well as frackers. It was one of the “hot” stocks of 2014 and rallied from $24 to $73, more than tripling in 7 months. As it began to decline, bargain-hunters started coming in. Notice how the red bars of the Impulse system kept telling buyers to leave it alone. Red bars prohibited buying. In area 1 the Impulse system went blue, then green, permitting buying, but quickly withdrew that permission when it turned red again in area 2. Another short-lived permission to buy in area 3 was cancelled in area 4. Those messages of the Impulse system helped shorts make money (that was the side I was on), but week after week told buyers to stay away, stay out of trouble.
The Impulse System isn’t a trading system – it’s a censorship system. It doesn’t tell you what to do – it shows what you’re not allowed to do. Find your trade using whatever system you like (we will review several systems below), but take a look at the Impulse system in your favorite (intermediate) timeframe as well as in the timeframe one order of magnitude longer before placing your order. The Impulse system will tell you whether you are allowed or not allowed to make that trade. Hold off entering a trade until the Impulse System releases you to act.
Every trade deserves a name (the system you trade)
As you scroll through the charts of various stocks, it is essential to have a very clear image in your mind of the pattern you’re looking for. Every trading system is designed to handle a specific price pattern. When you find a chart that matches that pattern, work up a possible trade.
Be sure to write a description of the system you’ll trade. What kind of pattern will it look for? What kind of stock? What rules will you use for entries and exits? Write down your answers to these questions. This discipline will put you miles ahead of most competitors.
“I heard good things about it” or “it looks kinda good” aren’t legitimate reasons to put on a trade. Each trade must be based on a specific system. You may have more than one system, but each trade must follow only one.
What class of trading vehicles will you trade? The best area for beginners is stocks. Avoid the delusion of buying options as a substitute for stocks, be super-cautious about ETFs and avoid leveraged ETFs like the plague. Leave those for day-traders only.
Which stocks will you trade? Set your minimum daily volume in order to avoid bad slippage in thinly traded stocks. I look for those that trade over a million shares per day. Avoid penny stocks, with their huge percentage swings – set your minimum price around $5.
Where will you look for trading ideas? Perhaps there are stock industry groups you’re interested in – select the most liquid, high-volume stocks in those groups and follow them on a daily basis. Don’t spread yourself too thin. The internet is brimming with stock tips, but trying to follow them is like drinking from a fire hose. Select one or two sources you trust – pay attention to them and go easy on the rest. StockCharts.com has several contributors who publish daily reports; I like piggy-backing ideas of the elite-level members of SpikeTrade.com; SeekingAlpha.com is worthwhile if you track fundamentals.
These and many other decisions are ahead of you. Don’t let things happen by default. Be mindful and alert. And now, let me show you a few systems, two of which are my own and two from the traders I respect.
Buying pullbacks in an uptrend
It feels tempting to buy a stock that’s hitting new highs, but many buyers get shaken out by pullbacks that tend to follow rallies. That’s how people end up buying high and selling low.
If you identify an uptrend and then wait for a pullback, you can get your stock at a discount (and if you don’t get it – forget it. There are many more fish in the sea). We can protect a pullback trade with a stop not too far away, and take profits when that stock rallies again.
If you compare a trend to a tide, a pullback is like a wave splashing against that tide.
The same approach works with selling short. Once we identify a downtrend, like a tide going out, wait for a counter-trend rally in order to sell short. Shorting is a very worthwhile activity, popular among professionals, but not suitable for beginners because stocks drop twice as fast as they rise. Shorting demands quick reactions and good risk management skills. Learn buying first and expand into shorting later.
To implement the pullback system, we’ll use two charts. We’ll make our strategic decision – to be a bull, a bear, or stand aside – on the weekly chart. If that chart is bullish, we’ll turn to the daily chart for tactical decisions on where to enter and place our stop and target. If the weekly chart is bearish or doubtful, let’s skip the daily and move on to the weekly chart of another stock.
There is a lot of chaos in the markets and when a stock looks doubtful, skip it and move on to the next candidate. Traders with a scientific background often have a fantasy that they can identify a trend by adding more tools, but no fancy indicators will clear up a chaotic market. A promising trade has to grab you by the face. When a stock’s trend is unclear, no amount of analysis will find a good trade.
Don’t waste your time on doubtful stocks – trade only those whose signals leap at you from the screen.
Here’s what we’ll be looking for:
* The weekly slow EMA is rising.
* The weekly Impulse system is green or blue (cannot be red).
* On the daily chart prices are in the value zone or below it (cannot buy above it).
* The daily Impulse system is blue (wait until it stops being red).
* The two-day Force Index is below zero.
Trade rules:
* Buy in the value zone on the daily chart.
* Place a stop near the low of the second lowest recent bar or 1.5 ATRs below your entry, whichever is lower. We’ll discuss ATRs in a chapter on stops.
* Set a target at least as high above value as the purchase is below. Attractive trades have
An end-of-day trend-following system
Most of us begin by reading about other people’s systems, finding one that appeals to us, and then using it. After a while most of us start tweaking our borrowed systems – until they gradually become as individual as we are. We may remember where our system had originally come from, but by now it has become our own.
Compare this to driving – whether you drive on the right or the left side of the road, or even down the middle of a dirt path in a remote area, your driving style is as personal as your signature. You obey safety rules, but the way you get from A to B reflects your style.
I think that the best place to see other people’s systems is SpikeTrade.com – an online community I co-lead with my friend Kerry Lovvorn. Our members compete for the best stock pick of the week, and as they post their trades, members get to see their systems and can ask them questions.
The following system comes from the section of SpikeTrade called “Q&A with A&K.” That’s where Kerry and I take turns answering members’ questions.
A member from South Carolina wrote: “I don't have the time to actively manage trades and would be interested in a simple swing trend-following system that I could check at end of each day. What are some suggestions for a system if one exists.”
Kerry replied: “Many of us tend to over-complicate our approaches to the market and lose sight of its basic principles. The difficulty with any trend-following system is the word "follow." A trend follower must put aside his thoughts and opinions and follow the trend as long as it remains in force.
“Whenever I build a trading system, I start with a core concept, such as ‘for an uptrend to remain in force, prices must keep making higher lows.’ This calls for buying when a potential uptrend is forming and selling when that trend may be ending. The idea is to catch short-term upswings that last 10 to 20 bars and ride them as long as a stock continues making higher lows. “Next, let’s define our parameters for buying and selling. We’ll use a variant of a moving average trend-following system, but with a twist: use an EMA of the lows rather than the usual EMA of closing prices.
Before we build a trading system let’s set up a censorship system. The Impulse system will keep us out of trouble by showing when not to trade. As Jesse Livermore, one of the great speculators of the 20th century, said to an interviewer: “There’s a time to be long, a time to be short, and a time to go fishing.”
The Impulse System applies a pair of indicators to any trading vehicle or an index: a fast exponential moving average and MACD-Histogram. The slope of the EMA reflects the direction of the market’s inertia. The slope of the last two bars of MACD-Histogram shows the direction of market power. Their combination colors every bar: green if both are rising, red if both are falling, and blue if they move in the opposite directions. When both the inertia and the power are pointing against your planned trade, you shouldn’t be getting into it.
* EMA rising & MACD-Histogram rising (especially below zero) = Impulse is green, bullish. Shorting is prohibited, buying or standing aside is permitted.
* EMA falling & MACD-Histogram falling (especially above zero) = Impulse is red, bearish. Buying is prohibited, shorting or standing aside is permitted.
* EMA rising & MACD-Histogram falling = Impulse is blue, neutral. Nothing is prohibited.
* EMA falling & MACD-Histogram rising = Impulse is blue, neutral. Nothing is prohibited.
When both indicators decline, showing that bears are in charge, they prohibit buying. When both rise, showing that bulls are in charge, they prohibit shorting. We need to check the colors of the Impulse system in two timeframes – our favorite (tactical, usually daily chart) and the chart one order of magnitude longer (strategic, usually weekly chart). If even one of them says ‘no’ to our trade, we should stand aside and wait for the Impulse system to release us to trade.
As for the indicator parameters, we can use a 13-bar EMA and a 12-26-9 MACD-Histogram. You may change these parameters, just be sure to use the same numbers consistently.
The Impulse system doesn’t mean “buy green, sell red,” as some copy-cats cheerfully until the Impulse turns green, you’ll miss the best opportunities. Our goal is to identify a potential buy early, while the Impulse system is still red, and then closely monitor that stock. As soon as the Impulse changes from red to blue, it removes its prohibition of buying and releases us to buy. Its best signals are given not by color (green or red), but by the disappearance of color (the Impulse stops being red or green and turns blue).
Silica Holdings Inc. (SLCA) serves oil producers in the Canadian tar sands as well as frackers. It was one of the “hot” stocks of 2014 and rallied from $24 to $73, more than tripling in 7 months. As it began to decline, bargain-hunters started coming in. Notice how the red bars of the Impulse system kept telling buyers to leave it alone. Red bars prohibited buying. In area 1 the Impulse system went blue, then green, permitting buying, but quickly withdrew that permission when it turned red again in area 2. Another short-lived permission to buy in area 3 was cancelled in area 4. Those messages of the Impulse system helped shorts make money (that was the side I was on), but week after week told buyers to stay away, stay out of trouble.
The Impulse System isn’t a trading system – it’s a censorship system. It doesn’t tell you what to do – it shows what you’re not allowed to do. Find your trade using whatever system you like (we will review several systems below), but take a look at the Impulse system in your favorite (intermediate) timeframe as well as in the timeframe one order of magnitude longer before placing your order. The Impulse system will tell you whether you are allowed or not allowed to make that trade. Hold off entering a trade until the Impulse System releases you to act.
Every trade deserves a name (the system you trade)
As you scroll through the charts of various stocks, it is essential to have a very clear image in your mind of the pattern you’re looking for. Every trading system is designed to handle a specific price pattern. When you find a chart that matches that pattern, work up a possible trade.
Be sure to write a description of the system you’ll trade. What kind of pattern will it look for? What kind of stock? What rules will you use for entries and exits? Write down your answers to these questions. This discipline will put you miles ahead of most competitors.
“I heard good things about it” or “it looks kinda good” aren’t legitimate reasons to put on a trade. Each trade must be based on a specific system. You may have more than one system, but each trade must follow only one.
What class of trading vehicles will you trade? The best area for beginners is stocks. Avoid the delusion of buying options as a substitute for stocks, be super-cautious about ETFs and avoid leveraged ETFs like the plague. Leave those for day-traders only.
Which stocks will you trade? Set your minimum daily volume in order to avoid bad slippage in thinly traded stocks. I look for those that trade over a million shares per day. Avoid penny stocks, with their huge percentage swings – set your minimum price around $5.
Where will you look for trading ideas? Perhaps there are stock industry groups you’re interested in – select the most liquid, high-volume stocks in those groups and follow them on a daily basis. Don’t spread yourself too thin. The internet is brimming with stock tips, but trying to follow them is like drinking from a fire hose. Select one or two sources you trust – pay attention to them and go easy on the rest. StockCharts.com has several contributors who publish daily reports; I like piggy-backing ideas of the elite-level members of SpikeTrade.com; SeekingAlpha.com is worthwhile if you track fundamentals.
These and many other decisions are ahead of you. Don’t let things happen by default. Be mindful and alert. And now, let me show you a few systems, two of which are my own and two from the traders I respect.
Buying pullbacks in an uptrend
It feels tempting to buy a stock that’s hitting new highs, but many buyers get shaken out by pullbacks that tend to follow rallies. That’s how people end up buying high and selling low.
If you identify an uptrend and then wait for a pullback, you can get your stock at a discount (and if you don’t get it – forget it. There are many more fish in the sea). We can protect a pullback trade with a stop not too far away, and take profits when that stock rallies again.
If you compare a trend to a tide, a pullback is like a wave splashing against that tide.
The same approach works with selling short. Once we identify a downtrend, like a tide going out, wait for a counter-trend rally in order to sell short. Shorting is a very worthwhile activity, popular among professionals, but not suitable for beginners because stocks drop twice as fast as they rise. Shorting demands quick reactions and good risk management skills. Learn buying first and expand into shorting later.
To implement the pullback system, we’ll use two charts. We’ll make our strategic decision – to be a bull, a bear, or stand aside – on the weekly chart. If that chart is bullish, we’ll turn to the daily chart for tactical decisions on where to enter and place our stop and target. If the weekly chart is bearish or doubtful, let’s skip the daily and move on to the weekly chart of another stock.
There is a lot of chaos in the markets and when a stock looks doubtful, skip it and move on to the next candidate. Traders with a scientific background often have a fantasy that they can identify a trend by adding more tools, but no fancy indicators will clear up a chaotic market. A promising trade has to grab you by the face. When a stock’s trend is unclear, no amount of analysis will find a good trade.
Don’t waste your time on doubtful stocks – trade only those whose signals leap at you from the screen.
Here’s what we’ll be looking for:
* The weekly slow EMA is rising.
* The weekly Impulse system is green or blue (cannot be red).
* On the daily chart prices are in the value zone or below it (cannot buy above it).
* The daily Impulse system is blue (wait until it stops being red).
* The two-day Force Index is below zero.
Trade rules:
* Buy in the value zone on the daily chart.
* Place a stop near the low of the second lowest recent bar or 1.5 ATRs below your entry, whichever is lower. We’ll discuss ATRs in a chapter on stops.
* Set a target at least as high above value as the purchase is below. Attractive trades have
An end-of-day trend-following system
Most of us begin by reading about other people’s systems, finding one that appeals to us, and then using it. After a while most of us start tweaking our borrowed systems – until they gradually become as individual as we are. We may remember where our system had originally come from, but by now it has become our own.
Compare this to driving – whether you drive on the right or the left side of the road, or even down the middle of a dirt path in a remote area, your driving style is as personal as your signature. You obey safety rules, but the way you get from A to B reflects your style.
I think that the best place to see other people’s systems is SpikeTrade.com – an online community I co-lead with my friend Kerry Lovvorn. Our members compete for the best stock pick of the week, and as they post their trades, members get to see their systems and can ask them questions.
The following system comes from the section of SpikeTrade called “Q&A with A&K.” That’s where Kerry and I take turns answering members’ questions.
A member from South Carolina wrote: “I don't have the time to actively manage trades and would be interested in a simple swing trend-following system that I could check at end of each day. What are some suggestions for a system if one exists.”
Kerry replied: “Many of us tend to over-complicate our approaches to the market and lose sight of its basic principles. The difficulty with any trend-following system is the word "follow." A trend follower must put aside his thoughts and opinions and follow the trend as long as it remains in force.
“Whenever I build a trading system, I start with a core concept, such as ‘for an uptrend to remain in force, prices must keep making higher lows.’ This calls for buying when a potential uptrend is forming and selling when that trend may be ending. The idea is to catch short-term upswings that last 10 to 20 bars and ride them as long as a stock continues making higher lows. “Next, let’s define our parameters for buying and selling. We’ll use a variant of a moving average trend-following system, but with a twist: use an EMA of the lows rather than the usual EMA of closing prices.
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