The stock market is generally thought to follow three trends, which market analysts have identified throughout history and can assume will continue in the future. These trends are as follows: the long-term trend lasting several years, the intermediate trend of several months and the minor trend that is generally thought to be anything less than several months.
Robert Rhea, one of the market's first technical analysts, labeled these trends as tides (long-term trends), waves (intermediate-term trends) and ripples (short-term trends). Trading in the direction of the market tide is generally the best strategy. Waves offer opportunities to get in or out of trades, and ripples should usually be ignored. While the trading environment has become more complicated since these simplified concepts were articulated in the first half of the 20th century, their fundamental basis remains true. Traders can continue to trade on the basis of tides, waves, and ripples, but the time frames to which these illustrations apply should be refined.
Under the triple screen trading system, the time frame the trader wishes to target is labeled the intermediate time frame. The long-term time frame is one order of magnitude longer while the trader's short-term time frame is one order of magnitude shorter. If your comfort zone, or your intermediate time frame, calls for holding a position for several days or weeks, then you will concern yourself with the daily charts. Your long-term time frame will be one order of magnitude longer, and you will employ the weekly charts to begin your analysis. Your short-term time frame will be defined by the hourly charts.
If you are a day trader who holds a position for a matter of minutes or hours, you can employ the same principles. The intermediate time frame may be a 10-minute chart; an hourly chart corresponds to the long-term time frame, and a two-minute chart is the short-term time frame.
First Screen of the Triple Screen Trading System: Market Tide
The triple screen trading system identifies the long-term chart, or the market tide, as the basis for making a trading decision. Traders must begin by analyzing their long-term chart, which is one order of magnitude greater than the time frame that the trader plans to trade. If you would normally start by analyzing the daily charts, try to adapt your thinking to a time frame magnified by five, and embark on your trading analysis by examining the weekly charts instead.
Using trend-following indicators, you can then identify long-term trends. The long-term trend (market tide) is indicated by the slope of the weekly moving average convergence divergence (MACD) histogram, or the relationship between the two latest bars on the chart. When the slope of the MACD histogram is up, the bulls are in control, and the best trading decision is to enter into a long position. When the slope is down, the bears are in control, and you should be thinking about shorting.
Any trend-following indicator that the trader prefers can realistically be used as the first screen of the triple screen trading system. Traders have often used the directional system as the first screen, or even a less complex indicator such as the slope of a 13-week exponential moving average can be employed. Regardless of the trend-following indicator that you opt to start with, the principles are the same: Ensure that you analyze the trend using the weekly charts first and then look for ticks in the daily charts that move in the same direction as the weekly trend.
Of crucial importance in employing the market tide is developing your ability to identify the changing of a trend. A single uptick or a downtick of the chart (as in the example above, a single uptick or a downtick of the weekly MACD histogram) would be your means of identifying a long-term trend change. When the indicator turns up below its center line, the best market tide buy signals are given. When the indicator turns down from above its center line, the best sell signals are issued.
The model of seasons for illustrating market prices follows a concept developed by Martin Pring. Pring's model hails from a time when economic activity was based on agriculture: seeds were sown in spring, the harvest took place in summer, and the fall was used to prepare for the cold spell in winter. In Pring's model, traders use these parallels by preparing to buy in spring, sell in summer, short stocks in the fall and cover short positions in the winter.
Pring's model is applicable in the use of technical indicators. Indicator "seasons" allow you to determine exactly where you are in the market cycle and to buy when prices are low and short when they go higher. The exact season for any indicator is defined by its slope and its position above or below the center line. When the MACD histogram rises from below its center line, it is spring. When it rises above its center line, it is summer. When it falls from above its center line, it is autumn. When it falls below its center line, it is winter. Spring is the season for trading long, and fall is the best season for selling short.
Whether you prefer to illustrate your first screen of the triple screen trading system by using the ocean metaphor or the analogy of the changing of the seasons, the underlying principles remain the same. (See also: Triple Screen Trading System - Part 3 and Triple Screen Trading System - Part 1.)