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. Wait until the Impulse system removes its prohibition.
* 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 declare. By the time the Impulse system turns green, the uptrend is well under way. If you wait to buy 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).
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To change your chart into an Impulse System chart:
1.) Find the “Type” dropdown located in the “Chart Attributes” area underneath the chart.
2.) Click on the dropdown and select “Elder Impulse System” from the very bottom of the list that appears
3.) Press the “Update” button
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.