Alexander Elder lays out the background and blueprint for
the Triple Screen Trading System (Triple Screen) in his book The New Trading
for a Living. Elder has been using this system since 1985 with a few minor
adjustments along the way. However, the basic premise remains. He states that
the Triple Screen makes “trading decisions using a sequence of timeframes and
indicators” (The New Trading for a Living, pg. 154). Specifically, there are
three screens applied to each trade and only the best trading opportunities
pass these tests. In practice, Triple Screen uses trend-following indicators on
longer term charts while the intermediate and short-term charts use oscillators
for analysis. Trend-following indicators work well for identifying the
existence of a trend, but fall short during a range bound market. Conversely,
oscillators demarcate overbought and oversold levels which are useful in a
trendless market, but will be consistently overbought or oversold when a trend
is emerging. As such, trend-following indicators and oscillators can be
complimentary to each other. The Triple Screen attempts to preserve the
strengths of both indicators while minimizing their weaknesses. For example,
when a weekly chart is in a downtrend but the daily chart is trending up a
trader needs to be equipped with tools to identify the strength of the dominant
(weekly) trend as well as the chance of the reversal in the secondary (daily)
price action.
Understanding this order of magnitude comes into play when
designing the Triple Screen around a trader’s favorite time frame. For example,
if a weekly chart is preferred then monthly would be one order longer and daily
one order shorter. The preferred timeframe is considered the intermediate
timeframe in the system. “The Triple Screen demands that you examine the
long-term chart first. It allows for you to trade only in the direction of the
tide (i.e. trend on the longer term chart)” (The New Trading for a Living, pg.
156). Looking back to the previous example, when the weekly trend is down any
move up in daily price action provides a shorting opportunity delineated by
overbought levels in an oscillator.
Understanding the timeframe methodology is imperative in
application. The first screen Elder defines as the Market Tide. Specifically,
Triple Screen starts by assessing the longer-term chart that is one time period
greater than the one a trader plans to trade. Elder believes that starting with
a longer term chart will give a trader a great advantage over other traders
trading in the same timeframe since using the Triple Screen will provide a more
strategic view of a market or security. As mentioned earlier, the longer
timeframe charts will use trend-following indicators. The Triple Screen began
with assessing the slope of the Moving Average Convergence Divergence Histogram
(MACD-H), progressed to using slope of an Exponential Moving Average (EMA), and
finally settled on implementing the Impulse System* (also developed by Dr.
Alexander Elder). Ultimately, it does not matter which trend-following
indicator a trader opts to use on the first screen, as long as on the chart of
one lesser magnitude trades are being identified that correspond with the
predominant trend.
The second screen under this method allows for a trader to
take signals in the primary trading timeframe that put a position in gear with
the larger trend. For instance, when the weekly trend is up, declines in the
daily chart provide buying opportunities, and vice versa. Implicitly, a trader
would use oscillators for these set ups. Oscillators identify trading ranges
and when a market is trending the highs and lows of the ranges identify selling
and buying opportunities from a long perspective and the converse when a
long-term trend is down. Examples of oscillators include Relative Strength
Index (RSI), Williams % R, Stochastics, or Elder’s Force Index. These
oscillators can be used independently or combined in some manner where a change
of direction in one may be confirmed by an overbought or oversold level in
another.
After the first two filters of the Triple Screen have been
applied to the trading process the third screen is imposed on a timeframe of
one magnitude shorter than the primary trading chart. For example, if daily
trades are the core of the system then looking at hourly or shorter charts will
allow for traders to identify set-ups that complement the daily perspective. In
practice this would require looking for breakouts or breakdowns on the shortest
time frame to recognize buying or shorting opportunities on the daily chart,
respectively. In other words, identifying these price thrusts on the shortest
timeframe will validate the turning points in the next higher order of
magnitude.
As with any method, sound risk management must be employed
in order to have a chance at profitability. Elder advises traders to write down
the entry price, target price, and the stop before entering a trade. Under the
Triple Screen, profit targets are set using the long-term charts and stops are
set based on the price action on the intermediate, primary, timeframe.
Operating a risk management system in this manner will set fairly tight stops
so it will become quickly apparent if a trade is not working out.
While no trading system is perfect the Triple Screen provides
active traders with a solid foundation for performing market analysis.
Moreover, the built-in risk management will protect capital when a trade does
not materialize. After experimenting with the basic system further
customization can be applied to enhance returns and risk measures.
Additionally, traders can build multiple Triple Screen systems trading on
different timeframes which could create new revenue opportunities. Ultimately,
the efficacy of a system will be determined by whether or not it creates
positive expectancy of outcomes (i.e. if it is profitable or not). With plenty
of leeway for experimentation, to learn about system design, to understand risk
management, as well as eliminate the psychological errors and biases from
discretionary trading, the Triple Screen is a good method for use by all skill
levels of traders.
*Dr. Alexander Elder created the Impulse System somewhat arbitrarily when he was traveling. He wanted to design a system that would describe any
market using two terms: Inertia and Power. Elder defines Inertia as the slope
of a security’s fast EMA. As with any trend analysis, a rising fast EMA denotes
bullish Inertia while a falling fast EMA indicates bearish Inertia. The slope
of the MACD-H defines the Power of a security. Traders can interpret the slope
of MACD-H just as fast EMA is analyzed. After some experimenting and
back-testing, Elder again had a moment of realization when the purpose of the
Impulse System changed from a trade identification system to a censorship
process. That is, it tells a trader what not to do. For example, when the slope
of the fast EMA (Inertia) and slope of MACD-H (Power) are up (bullish) no
shorting is permitted. Conversely, no buying is allowed when the opposite is
true for Inertia and Power. The effectiveness of the Impulse system in
identifying trends has been recognized by traders and understanding this
concept may help add perspective to one’s market analysis.
JD
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