The triple screen trading system is based on employing the best of both the trend-following indicators and oscillators to make trading decisions. Traders are primarily concerned with any realized divergences between the readings of a longer-term trend-following indicator such as a weekly moving average convergence divergence (MACD) histogram and the relatively shorter-term reading from an oscillator such as force index, Elder-Ray, stochastic or Williams %R.

The fourth section of this series will examine the means by which a trader would use the Elder-Ray oscillator as the market wave, which is the second screen of the trader's triple screen system.

Second Screen - Elder-Ray
Elder-Ray, devised by Dr. Alexander Elder, is based on the concepts of bull power and bear power, the relative strength of bulls and bears in the market. Bull power measures the ability of market bulls to push prices above the average consensus of value, which is the actual price at which a particular stock happens to be trading for a given point in time. Bear power is the bears' ability to drive prices lower than current prices, or the current average consensus of value.

By using a longer-term trend-following indicator, perhaps a weekly MACD histogram, traders can identify the direction of the longer-term trend. Bull power and bear power are then used to find trades on the daily charts that move in the same direction as the weekly trend. The triple screen earns its "screening" label because it eliminates all signals but those in the direction of the trend: if the weekly trend is up, only buy signals are returned from Elder-Ray. If the weekly trend is down, only Elder-Ray sell signals are considered.

Buy Signals
There are two absolutely essential conditions that need to be in place for traders to consider buying: 1) the weekly trend should be up, and 2) bear power, as represented on Elder-Ray, should be negative but rising. The second condition - negative bear power - is worth exploring. The opposite condition, in which bear power is positive, occurs in a runaway uptrend, a dangerous market environment for trading, despite the apparent strength of the trend. The problem with buying in a runaway uptrend is that you are betting on the greater fool theory, which states that your profit will be realized only by eventually selling to somebody willing to pay an even higher price.

When bear power is negative but rising, bears are showing a bit of strength but are beginning to slip once again. By placing a buy order above the high of the last two days, your stop order will be filled only if the rally continues. Once you have gone long, you can protect your position with a stop below the latest minor low.

Bullish divergences between bear power and price (average consensus of value) represent the strongest buy signals. If prices fall to a new low but bear power shows a higher bottom, prices are falling and bears become weaker. When bear power moves up from this second bottom, you can comfortably buy a larger number of shares than you typically would in your usual position.

You can also use Elder-Ray to determine the best time to sell your position. By tracking the pattern of peaks and valleys in bull power, you can ascertain the power of bulls. By stacking the peaks in actual price against the peaks in bull power, you can determine the strength of the uptrend - if every new peak in price comes along with a new peak in bull power, the uptrend is safe. When prices reach a new high but bull power reaches a lower peak than that of its previous rally, the bulls are losing their power and a sell signal is issued.

Elder-Ray as the second screen in the triple screen trading system can also be used to determine the conditions in which shorting is appropriate. The two essential conditions for shorting are, firstly, that the trend is down and, secondly, that bull power is positive but falling.

If bull power is already negative, selling short is inappropriate because bears have control over the market bulls. If you short sell in this condition, you are effectively betting that bears have sufficient strength to push bulls even farther under water. Furthermore, as in the case discussed above, wherein the trader holds a long position during positive bear power, you are betting on the greater fool theory.

When bull power is positive but falling, the bulls have managed to grasp a bit of strength but are beginning to sink once again. If you place a short order below the low of the last two days, you receive an order execution only if the decline continues. You can then place a protective stop above the latest minor high.

Bearish divergences between bull power and prices (average consensus of value) give the strongest shorting signals. If prices hit a new high but bull power hits a lower top, the bulls are weaker than before, and the uptrend may not continue. When bull power inches down from a lower top, you can safely sell short a larger-than-usual position.

You can also determine when to cover your short positions on the basis of a reading of Elder-Ray. When your longer-term trend is down, bear power will indicate whether bears are becoming stronger or weaker. If a new low in price occurs simultaneously with a new low in bear power, the current downtrend is relatively secure.

A bullish divergence issues a signal to cover your shorts and prepare to enter into a long position. Bullish divergences occur when prices hit a new low and bear power hits an even shallower bottom, when bears are losing their momentum and prices are falling slowly.

For both long and short positions, divergences among bull power, bear power and prices indicate the best trading opportunities. In the context of the long-term trend indicated by our first market screen, Elder-Ray identifies the moment when the market's dominant group falters below the surface of the trend.

The Bottom Line
For more about the second screen of the triple see Triple Screen Trading System - Part 5. You can also check out Part 1, Part 2 and Part 3 of this series.

Related Articles
  1. Options & Futures

    Profiting In Bear And Bull Markets

    There are many ways to profit in both bear and bull markets. The key to success is using the tools for each market to their full advantage.
  2. Fundamental Analysis

    7 Controversial Investing Theories

    We take a closer look at the theories that attempt to explain and influence the market.
  3. Options & Futures

    Forget The Stop, You've Got Options

    Using options instead of stop-loss orders adds finesse and control in limiting losses.
  4. Active Trading Fundamentals

    Surviving Bear Country

    Stay calm, play dead and keep your eyes open for attractive valuations.
  5. Options & Futures

    Protect Yourself From Market Loss

    There are several simple strategies you can use to protect yourself from downside risk.
  6. Mutual Funds & ETFs

    Surf's Up With Filtered Waves

    With an appropriate filter, you can ride the waters to rising profits.
  7. Active Trading Fundamentals

    The Stop-Loss Order - Make Sure You Use It

    It's a simple but powerful tool to help you implement your stock-investment strategy. Find out how.
  8. Term

    Understanding Short Covering

    Short covering is buying back borrowed securities to close an open short position.
  9. Technical Indicators

    Explaining Autocorrelation

    Autocorrelation is the measure of an internal correlation with a given time series.
  10. Chart Advisor

    ChartAdvisor for October 9 2015

    Weekly technical summary of the major U.S. indexes.
  1. What are some of the most common technical indicators that back up Doji patterns?

    The doji candlestick is important enough that Steve Nison devotes an entire chapter to it in his definitive work on candlestick ... Read Full Answer >>
  2. Tame Panic Selling with the Exhausted Selling Model

    The exhausted selling model is a pricing strategy used to identify and trade based off of the price floor of a security. ... Read Full Answer >>
  3. Point and Figure Charting Using Count Analysis

    Count analysis is a means of interpreting point and figure charts to measure vertical price movements. Technical analysts ... Read Full Answer >>
  4. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
  5. How are double exponential moving averages applied in technical analysis?

    Double exponential moving averages (DEMAS) are commonly used in technical analysis like any other moving average indicator ... Read Full Answer >>
  6. How do you know where on the oscillator you should make a purchase or sale?

    Common oscillator readings to consider making a buy or sale are below 20 or above 80, respectively. More aggressive investors ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges ...
  2. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  3. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
  4. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  5. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  6. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!