The Impulse Trading System works in any timeframe, including intraday
High volatility during the bull market of the 1990s made momentum trading very popular. The idea is to jump aboard a fast-moving stock as it begins to run and hop off after it slows down. Momentum traders do not care about company fundamentals; they may not even know what that company does. All they care about is direction and speed. They buy when a stock rallies (they rarely go short) and hope to cash out before the impulse runs out.
The game of momentum trading appears deceptively easy. The owners of trading rooms make fortunes in commissions, while legions of traders lose even bigger fortunes trying to grab money from fast moving stocks. Impulse trading tends to degenerate into impulsive trading, and the game is over.
Momentum trading has a built-in psychological contradiction that's deadly to most people. On the one hand, this fast game, like infantry fighting or video game playing, is best suited for young people with strong hunting instincts, capable of abandoning themselves to the game. On the other hand, momentum trading requires the cold detached discipline of a professional card counter in a casino. Successful momentum trading, like professional gambling, is a boring business. The ability to accept small steady gains-essential for momentum trading-is very rare. Few people can walk away from the table just as the party gets going.
One of my favorite clients is a professional trader in London who sometimes, for entertainment, goes to a casino at night. He plays blackjack for a minimum stake of ? 5 and quits when he is either ? 200 ahead or ? 400 behind. He has worked out a card-counting method and a money management system that have him going home with ? 200 13 times out of 14. He has proven to himself that he can steadily win at the casino, and now he rarely goes there because he must spend 6 or 7 hours counting and betting before reaching his winning or losing limit. It is hard work, counting all the time. The crowd of amateurs around him is having a lot of fun losing. My client prefers to stay home and trade stocks where the odds are much more to his liking.
Successful momentum trading requires great discipline. You must identify a price move, hop aboard without waiting for a better confirmation, and jump off as soon as that move slows down. The longer
you wait to identify the momentum, the less money is left for you. Taking profits is stressful because of a normal human tendency to hold out for a little more and then beat yourself up for having left too early. A momentum trader needs a set of technical rules, a money management system, and iron discipline to enter when the time is right and exit without regrets after hitting his profit target or a loss limit.
Entries
I designed this system to identify the inflection points where a trend speeds up or slows down. The Impulse System works in any timeframe, including intraday. It provides buy and sell signals, but leaves it up to you to select good markets, tweak parameters, and supply the discipline.
Choose an active market whose prices swing in a broad channel. What happens if you make a C trade and grab only 10% of a channel width? This result is not too bad if the channel is 20 points wide, but a C trade is an exercise in futility if the channel is only 5 points wide. Chase fat rabbits, don't waste your time on skinny ones.
The Impulse System combines two simple but powerful indicators. One measures market inertia, the other its momentum. When both point in the same direction, they identify an impulse worth following. We get an entry signal when both indicators get in gear, but as soon as they stop confirming one another, we take that as an exit signal.
The Impulse System uses an exponential moving average to find uptrends and downtrends. When the EMA rises, it shows that inertia favors the bulls. When EMA falls, inertia works for the bears. The sec ond component is MACD-Histogram, an oscillator whose slope reflects changes of power among bulls or bears. When MACD-Histogram rises, it shows that bulls are becoming stronger. When it falls, it shows that bears are growing stronger.
The Impulse System flags those bars where both the inertia and the momentum point in the same direction. When both the EMA and MACD-Histogram rise, they show that bulls are roaring and the uptrend is accelerating. When both indicators fall together, they show that bears are crushing the market. Those indicators may stay in gear with each other for only a few bars, but that's when the market travels fast-the impulse is on!
Before you rush to apply the Impulse System to your favorite market, remember how Triple Screen analyzes markets in more than one
timeframe. Select your favorite timeframe and call it intermediate. Multiply it by five to define your long-term timeframe. If your favorite chart is daily, analyze the weekly chart to make a strategic decision to be a bull or a bear. Use a 26-week EMA, the slope of weekly MACD Histogram, or both, on the weekly chart.
Once you've defined the long-term trend, return to your daily chart and look for trades only in the direction of the weekly. The Impulse System uses a 13-day EMA and a 12-26-9 MACD-Histogram. The EMA, tracking market inertia, is a little shorter than our usual 22 bars, making the system more sensitive.
When the weekly trend is up, turn to the daily charts and wait for both the 13-day EMA and MACD-Histogram to turn up. When both inertia and momentum rise, you have a strong buy signal, telling you to get long and stay long until the buy signal disappears.
When the weekly trend is down, turn to the daily charts and wait for both the 13-day EMA and MACD-Histogram to turn down. They give you a signal to go short, but be ready to cover when that signal disappears.
Some technical programs allow you to mark price bars with different colors. Make them green when both the EMA and MACD-Histogram rise, and red when both indicators fall. Don't mark the bars where the indicators point in the opposite directions. This lets you easily see signals at a glance.
Programming differs for different software packages, but here's how I programmed buy signals into Internet Trader Pro:
If you know how to program, you can add more features to the sys tem. You can make its EMA length variable and test different lengths, looking for those that work best in your market. You can program sound alarms for buy and sell signals and monitor a number of mar kets without being glued to the screen. There is a fisherman on the esplanade near where I live who has several fishing poles, each with a little bell. Whenever a fish bites, a bells rings, the man puts his newspaper down and starts reeling it in.
Exits
When a cowboy at a rodeo hops on the back of a wild bronco, how long does he ride it? Twenty seconds, 35 maybe, 50 if he is good and lucky. Wild momentum trades don't last long either. Try to hop off while you're still in the money.
The time to buy into a momentum trade is when all your ducks are in a row, that is, when the weekly trend is up and the daily EMA and MACD-Histogram are rising. Hop off as soon as a single indicator turns down. Usually, daily MACD-Histogram turns first as the upside momentum starts weakening. When the buy signal disappears, sell without waiting for a sell signal.
Reverse the procedure in downtrends. A momentum trade on the short side starts when the weekly trend turns down and the daily EMA and MACD-Histogram also fall, showing that the downward momen tum is accelerating. Cover shorts as soon as one of those indicators stops giving a sell signal. The most dynamic part of the decline is over, and your momentum trade has fulfilled its goal.
The Impulse System encourages you to enter cautiously but exit fast. This is the professional approach to trading, the total opposite of the amateurs' style. Beginners jump into trades without thinking too much and take forever to get out, hoping and waiting for the market to turn their way.
The Impulse System, like Triple Screen, is a method of trading rather than a mechanical system. It identifies islands of order in the ocean of market chaos by showing when the crowd, usually so aimless and disorganized, becomes emotional and starts to run. You get in when its pattern emerges and hop off when it starts to sink back into chaos.
Test the Impulse System on your own market data to answer several important questions. Should you enter and exit at the open, after see ing the signal in the evening, or should you try to anticipate those signals? What if you do your homework 15 minutes before the close and buy or sell without waiting for tomorrow? Experiment with several dif ferent parameters of the EMA and MACD-Histogram.
You must be very disciplined to trade this system because it is hard to place an order when the market is already flying, but even harder to quit while you're ahead without waiting for a reversal. You are not allowed to kick yourself if the trend continues after you get out. Do not touch this system if you have the slightest problem with discipline
The Impulse System can help you trade other systems. Check its message when Triple Screen gives you a signal to buy. If the Impulse System flashes a sell signal, hold off buying; do not trade against it. You want to buy a dip, not a waterfall decline. Reverse the procedure in downtrends. Hold off shorting if the Impulse System flashes a buy signal. Such "negative rules," designed to keep you out of trouble, are among the most useful for serious traders.
