How to use the impulse system

Alexander Elder described the system as follows: The Impulse system was introduced in my 2002 book Come into My Trading Room and described in all my subsequent books.  It’s becoming more and more popular among traders, but many casual users misuse it.  Some apply it to a single timeframe, while you must track at least two.  Others think that green bars are to be bought and red ones to be short, which is a very lame interpretation.  Let me clarify its rules… The absolute key thing to keep in mind is this: the Impulse system is not a trading system.  It is a censorship system.  It does not tell you what to do.  It tells you what you are not allowed to do. Green means no shorting allowed.  Red means no buying allowed.  Blue is neutral. Let’s review the Japanese Yen for example, although these rules apply to stocks, futures, and all timeframes.  The yen had a horrific slide.  When its weekly chart, shown above, slid below the lower channel line, I became eager to buy, expecting a bounce, but the Red Impulse forced me to sit on my hands – no buying allowed.  As the weekly turned Blue, it released me to buy and I turned to the daily charts.  I traded Yen long last week in the Alps and again this week in New York. You see, the Impulse system did not tell me to go buy Yen – my other analysis did.  The Impulse system simply kept me out of trouble, not letting me “catch a falling knife.”  When it released me I turned to the dailies. Here you see that on Tuesday the daily bar was Red – no buying permitted.  On Wednesday it turned Blue – OK to buy.  On Thursday it turned Green – and in my view it is no longer the time to buy but to consider taking profits into strength. If you want to take the Impulse to the next level of sophistication, you can calculate at what level the Impulse color will change.  I often use those levels when angling for entries and exits. Take a look, for example, at this daily chart of Ultra Petroleum Corp. (UPL).  The stock is building a bullish divergence on the weekly chart (not shown).  The daily has cracked below support and stopped declining – a potential false breakout, one of the strongest buy signals.  The Impulse system is Red, prohibiting buying.  Do you see faint yellow dots above the bars?  I marked some of them with slanted arrows.  Those dots are drawnby an indicator called MACD XOver – it shows at what level the Red or the Green color will disappear and change to Blue.  That might be a good level for a buy order.

Handling Losses

Losses are part of the game.  But they are frustrating. I had two last month that were particularily frustrating.  INVN and WFM.  The reason that both are so frustrating is that I had decent gains before giving them up and winding up with a small loss in each position.  

INVN was one of those momentum stocks where you have to sell when you are ahead and every thing looks like its going higher.  WFM is the type of trade that is going to happen.  I was right on the technicals and the trade moved in my direction until Goldman Sachs downgraded it, which took my stop out.

Although frustrating, I stuck to my plan and did not let a small loss turn large.  The result is that these trades only did minimal damage to the account.  My winners more than made up for these losses.  Had I attempted to rationalize or hold on, I would have seen another 1.50 or more lost in INVN.

That's the point.  Losses will happen.  If the rules are followed, who cares? The winners will make more than make up for them.