Fly Fishing the Stock Market: How to Search for, Catch, and Net the Market's Best Trades

THE IMPULSE SYSTEM

This method of market analysis was created by Dr. Alexander Elder and described in his book Come Into My Trading Room. The Impulse system identifies trend changes. Its components are an exponential moving average, which measures the inertia of a security, and MACD histogram, which measures its momentum.

An upsloping EMA reflects bullish inertia, while a downsloping EMA identifies bearish inertia. A rising MACD histogram identifies bullish momentum, while a falling MACD histogram reflects bearish momentum.

If both the EMA and MACD histogram are rising, they show that both inertia and momentum are in gear to the upside. That bar is colored green, and it means that only long trades are permitted, while shorting is prohibited. If both are in gear to the downside, the bar is colored red. It means that only shorting is allowed, while buying is prohibited. When the slope of the EMA is in conflict with the slope of the MACD histogram, either long or short trades are allowed, and the bar is colored blue.

In his book, Sell and Sell Short, Dr. Elder writes the following:

The Impulse system works best as a censorship method. When the Impulse is green, you may buy or stand aside but absolutely no shorting is permitted. When the Impulse is red, you may go short or stand aside but buying is prohibited. I wait for the Impulse system to go “off green” before shorting and “off red” before buying.

Many charts in this book have color-coded price bars (Figure 2.29). They follow the ...