I had a friend who drove a tank in World War ll, fighting his way from Stalingrad to Vienna. He maintained his tank with only three tools-a big hammer, a big screwdriver, and the Russian version of "f... you." He won the war with a few simple tools, and we can apply his lessons to the dangerous environment of the markets.

An amateur tries to grab a bit of money here and there. He uses one technique today and another tomorrow. His mind is scattered and he keeps losing, enriching only his broker and floor traders. A new hunter walks into the woods with a load of fancy gear on his back but soon discovers that most of it only slows him down. An experienced woodsman travels light.

A beginner shoots at anything that moves, including his own shadow. An old hunter knows exactly what prey he is after and brings only a few bullets. Simplicity and discipline go hand in hand. To be a successful trader, choose a small number of markets, select a few tools, and learn to use them well. If you follow five stocks, your research will be deeper and results better than if you follow 50. If you use five indicators, you'll get more mileage out of them than out of 25. You can always expand later, once you make steady profits.

The indicators we are about to discuss represent the choice of one trader. I call this approach "five bullets to a clip." An old army rifle used to take five bullets, and I analyze markets using no more than five indicators.

If five do not help, 10 will not do any better because there probably is no trade. I offer you this list as a starting point for selecting your own bullets. Pay attention to the general principle of selecting indicators from different groups to focus on different aspects of crowd behavior. The key idea is to select a few core tools that fit your style of analysis and trading.

The tools we are about to review-moving averages, envelopes, MACD, MACD-Histogram, and Force Index-are the building blocks of a trading system described in the following chapter. There is no magic indicator; they all have advantages and disadvantages. It is important to be aware of both because then we can combine several indicators into a system to take advan-tage of their strengths, while their disadvantages cancel each other out.

Choice of Tools

Markets can confound traders. They often run in two directions at once- up on the weekly charts and down on the dailies. A market equity value can reverse without sending you an e-mail about its change of plans. A sleepy stock price can get so hot that it burns through stops, while a formerly hot stock becomes so cold it freezes your capital along with your fingers.

Trading is a complex, nontrivial game. Markets consist of huge crowds of people, and technical analysis is applied social psychology. We must select several tools to identify different aspects of market behavior. Before using any indicator, we must understand how it is constructed and what it measures. We must test it on historical data and learn how it performs under different conditions. Once you start testing an indicator, expect to adjust its settings, turning it into a personal trading tool as reliable and familiar as an old wrench.

Toolboxes vs. Black Boxes I keep seeing ads in traders' magazines that show computers with $100 bills coming out of their disk drives. I'd love to get a hold of one of those models. The only ones I could find have the direction of money reversed. Computers can chew up cash, but pulling it out of them takes a lot of hard work. Those ads sell black boxes-computerized trading systems. Some clown has programmed a bunch of trading rules, put them on a copy-protected diskette or a CD, and now sells you a tool with a great track record. Feed it market data, and it will spit out an answer-when to buy or sell! If you believe this magic, wait until you meet Santa Claus.

A fantastic track record of a canned system is meaningless because it comes from fitting the rules to old data. Any computer can tell you which rules worked in the past. Black-box programs self-destruct as soon as the markets change, even if they include self-optimization. Black boxes appeal to beginners who derive a false sense of security from them. A good software package is a toolbox-a collection of tools for analyzing markets and making your own decisions. A toolbox can download data, draw charts, and plot indicators, as well as any trading signals you care to program. It provides charting and analytic tools but leaves you to make your own trading decisions.

The heart of any toolbox is its collection of indicators-tools for iden-tifying trends and reversals behind the noise of raw data. Good toolboxes allow you to modify indicators and even design your own. Indicators are objective; you may argue about the trend, but when an indicator is up, it's up, and when it is down, it's down. Keep in mind that indicators are derived from prices. The more complicated they are, the farther they are from prices and the farther away from reality. Prices are primary, indica-tors are secondary, and simple indicators work best.

Trend-Following Indicators and Oscillators Learning to use indicators is like learning a foreign language. You have to immerse yourself in them, make typical beginners' mistakes, and keep practicing until you rise to the level of proficiency and competence.

Good technical indicators are simple tools that perform well when market conditions change. They are robust, that is, relatively immune to parameter changes. If an indicator gives great signals using a 17-day window but bombs when you try a 15-day window, then it's probably useless. Good indicators give useful signals at a broad range of settings.

We can divide all technical indicators into three major groups: trend-following, oscillators, and miscellaneous. Whenever we use an indicator, we must know to which group it belongs. Each group has its advantages and disadvantages.

Trend-following indicators include moving averages, MACD (moving average convergence-divergence), Directional System, and others. Big trends mean big money, and these indicators help us stay long in uptrends and short in downtrends. They have built-in inertia that allows them to lock onto a trend and ride it. That same inertia causes them to lag at turning points. Their advantages and disadvantages are the flip sides of each other, and you cannot have one without the other.

Oscillators include Force Index, Rate of Change, and Stochastic, among others. They help catch turning points by showing when markets are overbought (too high and ready to fall) or oversold (too low and ready to rise). Oscillators work great in trading ranges, where they catch upturns and downturns. Taking their signals when prices are relatively flat is like going to a cash machine-you always get something, although not very much. Their downside is that they give premature sell signals in uptrends and buy signals in downtrends.

Miscellaneous indicators, such as Bullish Consensus, Commitments of Traders, and New High-New Low Index, gauge the current mood of the market. They show whether the overall bullishness or bearishness is rising or falling.

Indicators from different groups often contradict one another. For example, when markets rise, trend-following indicators turn up, telling us to buy. At the same time, oscillators become overbought and start flashing sell signals. The opposite occurs in downtrends, when trend-following indicators turn down, giving sell signals, while oscillators become oversold, flashing buy signals. Which should we follow? The answers are easy in the middle of a chart, but much harder at the right edge, where we must make our trading decisions.

Some beginners close their eyes to complexity, choose a single indicator, and stick to it until the market whacks them from an unexpected direction. Others create a homemade opinion poll; they take a battery of indicators and average their signals. This is a meaningless exercise because its outcome depends on what indicators you include in your poll; change the selection and you'll change the outcome. The Triple Screen trading system, described below, overcomes the problem of conflicting indicators by linking them with different timeframes.

Time - The Factor of Five A computer screen can comfortably show about 120 bars in an open-high-low-close format. What if you display a monthly chart, each of whose bars represents one month? You'll see 10 years worth of history at a glance, your stock's big picture. You can display a weekly chart and review its rallies and declines for the past two years. A daily chart will show you the action for the past few months. How about an hourly chart, each of whose bars represents one hour of trading? It will let you zoom in on the past few days and pick up short-term trends. Want to get even closer? How about a 10-minute chart, each of whose bars represents 10 minutes of market action?

Looking at all these charts, you quickly notice that markets can move in different directions at the same time. You may see an upmove on the weekly chart, while the dailies are breaking down. An hourly chart may be sagging, while a 10-minute chart is rallying. Which trend to follow?

Most beginners look at only one timeframe, usually daily. The trouble is that a new trend, erupting from another timeframe, often hurts traders who do not look beyond their noses. Another serious problem is that looking at the daily chart puts you on par with thousands of other traders who also look at it. What's your advantage, what's your edge?

Markets are so complex that we must always analyze them in more than one timeframe. The Factor of Five, first described in Trading for a Living, links all timeframes. Every timeframe is related to the next higher and the next lower by the factor of five. There are almost five (4.3 to be exact) weeks to a month, five days to a week, and close to five hours in many trading days. We can break an hour into 10-minute segments and those into 2-minute bars.

The key principle of Triple Screen, which we will review later, is to choose your favorite timeframe and then immediately go up to the time-frame one order of magnitude higher. There we make a strategic decision to go long or short. We return to our favorite timeframe to make tactical decisions about where to enter, exit, place a profit target and a stop. Adding the dimension of time to our analysis gives us an edge over the competition.

Use at least two, but not more than three, timeframes because adding more only clutters up the decision-making process. If you are day-trading with 30and five-minute charts, then a weekly chart is essentially irrelevant. If you are trading market swings using a weekly and a daily, then the wiggles of a five-minute chart are no more than noise. Choose your favorite timeframe, add the timeframe one order of magnitude higher, and start your analysis at that point.