free download links about online stock trading, forex, futures, stock investing, market, trading systems
New Indicators, ELDER-RAY
Back to contents page

Elder-ray is a new technical indicator. It was developed in 1989 by this author and named for its similarity to X-rays. Doctors use X-rays to see bone structure below the surface of the skin. Traders can use Elder-ray to see the power of bulls and bears below the surface of the markets.

To be a successful trader, you do not have to forecast the future. You need to find when bulls or bears are in control and trade with the dominant group. Elder-ray helps you see when bulls and bears become stronger or weaker.

How to Construct Elder-ray

Elder-ray combines the best features of trend-following indicators and oscillators (see Section 24). It includes an exponential moving average, which is a trend-following indicator. Its Bull Power and Bear Power components are oscillators.

To create Elder-ray, divide your computer screen or chart paper into three horizontal windows. Plot a bar chart and an exponential moving average (EMA) in the upper window. Plot Bull Power in the middle window and Bear Power in the bottom window.

It takes four steps to construct Elder-ray

•  Draw a bar chart of any trading vehicle in the top window of your
screen.

•  Plot an EMA of closing prices in the same window. A 13-day EMA is
a good choice.

Bull Power = High-EMA Bear Power = Low - EMA

3. Calculate Bull Power according to the above formula. Plot it as a his­
togram in the middle window. Bull Power of any day equals the high
of that day minus the EMA of that day. Nonnally, the high of a bar is
above the EMA, Bull Power is positive, and the histogram is above

the centerline. The entire bar may sink below the EMA during a sharp break. When the high is below the EMA, Bull Power turns negative and its histogram falls below the centerline.

4. Calculate Bear Power and plot it as a histogram in the bottom window. Bear Power of any bar equals the low of that bar minus the EMA. Normally, the low of a bar is below the EMA, Bear Power is negative, and the histogram is below the centerline. If the entire bar rises above the EMA during a sharp rally, then Bear Power turns positive and its histogram rises above the centerline (Figure 41-2).

Trading Psychology

Elder-ray combines several pieces of information: price, a moving average, the high of each bar, and the low of each bar. We need to understand their meaning in order to understand Elder-ray.

Each price is a momentary consensus of value (see Section 12). Buyers are buying because they expect prices to rise. Sellers are selling because they expect them to fall. The undecided traders are standing aside, but their presence puts pressure on bulls and bears. A trade takes place when a buyer is willing to buy and a seller is willing to sell, both prompted by fear that an undecided trader may step in and snap away an opportunity. The price of every trade reflects the latest consensus of value of any trading vehicle.

A moving average shows the average consensus of value during its time window. A 10-day MA represents the average consensus of value for the past 10 days, a 20-day MA for the past 20 days, and so on. An exponential moving average is more reliable than a simple MA (see Section 25). The most important message of a moving average is its slope. When it rises, it shows that the crowd is becoming more bullish. When it declines, it shows that the crowd is becoming more bearish. Trade in the direction of the slope of a moving average.

The high of any bar reflects the maximum power of bulls during that bar. Bulls make money when prices rise. They keep buying until they cannot lift prices any higher. Bulls would love to raise prices one more tick —but they are out of breath. The high point of a daily bar represents the maximum power of bulls during the day, the high point of a weekly bar represents the maximum power of bulls during the week, and so on.

The low of any bar represents the maximum power of bears during that

The 13-day EMA reflects the average consensus of value; its slope identifies the market trend. Bull Power reflects the ability of bulls to lift prices above the average consensus of value. Bear Power reflects the ability of bears to push prices below the average consensus of value.

The best buy signals are given by bullish divergences-when prices fall to a new low, but Bear Power stops at a more shallow bottom. The best shorting signals are given by bearish divergences-when prices rise to or above the previous high, but Bull Power reaches a lower peak.

A bearish divergence in June and July gave a sell signal-a double top in price, accompanied by a lower peak in Bull Power. The sell signal was confirmed when the 13-day EMA turned down. Bull Power became positive several times during the downtrend, showing where to add to short positions. When Bull Power turns positive during a downtrend and then ticks down, place an order to sell short below the last day's low.

A bullish divergence developed in September when gold fell to a new low, but Bear Power made a more shallow low. The buy signal was confirmed when the 13-day EMA of gold turned up. At the right edge of the chart, the new peak in Bull Power confirms that the rally is strong and likely to continue.

bar. Bears make money when prices fall. They keep selling and shorting until they cannot push prices down another tick. The lowest point of a daily bar reflects the maximum power of bears during the day, the low of a weekly bar shows the maximum power of bears during the week, and so on.

Elder-ray compares the maximum power of bulls and bears to the average consensus of value. It does this by measuring the spread between the high and the low of every bar and an exponential moving average.

Bull Power reflects the bulls' ability to push prices above the average consensus of value. It measures the distance from the bar's high to the EMA. Bull Power is normally positive. It rises when bulls become stronger and falls when they stumble. Bear Power turns negative when bulls' heads are under water.

Bear Power reflects the bears' ability to push prices below the average consensus of value. It measures the distance from the bar's low to the EMA. Bear Power is normally negative. It deepens when bears grow stronger and rises when they become weaker. If Bear Power turns positive, it shows that very strong bulls are holding bears up in the air by the scruff of their necks.

To summarize the key points of Elder-ray:

•  Price is a consensus of value, expressed in action.

•  A moving average is an average consensus of value.

•  The highest point of each bar represents the maximum power of bulls
during that bar.

•  The lowest point of each bar represents the maximum power of bears
during that bar.

•  Bull Power is the difference between the raw power of bulls and the
average consensus of value.

•  Bear Power is the difference between the raw power of bears and the
average consensus of value.

Trading Rules

Elder-ray can work as a stand-alone trading method, but it pays to combine it with another method, such as the Triple Screen trading system (see Section 43). If you use Elder-ray alone, remember that the slope of its EMA identifies

the trend, and trade only in that direction. Use Bull Power and Bear Power to find entry and exit points for your trades in the direction of that trend.

Triple Screen, on the other hand, identifies the trend using weekly charts. It then uses Bull Power and Bear Power on the daily charts to find trades in the direction of the weekly trend. If the weekly trend is up, Triple Screen takes only buy signals from daily Elder-ray. If the weekly trend is down, it takes only shorting signals from daily Elder-ray.

Buying and Selling

There are two essential conditions for buying:

•  The trend is up (identified by EMA or a weekly trend-following indi­
cator).

•  Bear Power is negative but rising.

The third and fourth conditions are desirable but not essential:

•  The latest peak in Bull Power is higher than the previous peak.

•  Bear Power is rising from a bullish divergence.

Do not buy when Bear Power is positive. This occurs in runaway uptrends, when the entire bar rises above the EMA. If you buy when bears are being held up in the air, you are betting on the greater fool theory —paying a high price and hoping to meet a greater fool down the road willing to buy from you at an even higher price.

The best time to buy is when Bear Power is negative but rising—when bears regain their footing but are starting to slip again. When Bear Power ticks up, place a buy order above the high of the last two days. If the rally continues, your stop will be touched and you will go long. Once long, place a protective stop below the latest minor low.

The strongest buy signals are given by bullish divergences between Bear Power and price. If prices fall to a new low but Bear Power traces a higher bottom, it shows that prices are falling out of inertia and bears are becoming weaker. When Bear Power ticks up from the second bottom, buy a larger than usual position.

Bear Power is useful for deciding when to pyramid. As the uptrend continues, you can add to your long position whenever Bear Power dips below its centerline and then ticks up again.

If you buy using indicators, use them to decide when to sell. Do not be distracted by every uptick and downtick of Bull Power—its normal breath­ing process. You can monitor the power of bulls by tracking the pattern of peaks and valleys in Bull Power. As long as every new peak in price is accompanied by a new peak in Bull Power, the uptrend is safe. Sell when bulls start losing power. A sell signal is given when prices reach a new high but Bull Power reaches a lower peak than it reached during its previous rally.

Shorting and Covering

There are two essential conditions for shorting:

•  The trend is down (identified by EMA or weekly trend-following indi­
cator).

•  Bull Power is positive but falling.

The third and fourth conditions are desirable but not essential:

•  The latest bottom in Bear Power is deeper than its previous bottom.

•  Bull Power is falling from a bearish divergence.

Do not sell short if Bull Power is already negative. This happens when the whole price bar is below the EMA — during a waterfall decline. If you sell short when bears already have bulls' heads under water, you are betting that bears can push bulls' heads even deeper. This is another version of the greater fool theory.

The best time to sell short is when Bull Power is positive but falling. It shows that bulls have come up for air but are starting to sink again. Place an order to sell short below the low of the last two days. If the decline continues, you will be stopped in automatically. Once short, place a protective stop above the latest minor high.

The strongest shorting signals are given by bearish divergences between Bull Power and prices. If prices rally to a new high but Bull Power reaches a lower top, it shows that bulls are weaker than before and prices are rising out of inertia. When Bull Power ticks down from a lower top, sell short a bigger position.

Bull Power shows when to pyramid short positions. As a downtrend continues, you can add to your shorts whenever Bull Power rallies above its cen-terline and then ticks down again.

If you sell short using indicators, use them also for deciding when to

cover. When the trend is down, monitor Bear Power to see whether bears are becoming stronger or weaker. The pattern of peaks and valleys in Bear Power is much more important than its single upticks and downticks. If a new low in price is accompanied by a new low in Bear Power, the downtrend is safe.

A bullish divergence occurs when prices fall to a new low but Bear Power traces a more shallow bottom. It shows that bears are running out of steam and prices are falling out of inertia. This is a signal to cover shorts and get ready to go long.

Divergences between Bull and Bear Power and prices mark the best trad­ing opportunities. X-rays show broken bones under healthy skin—and Elder-ray shows when the dominant group is broken below the surface of a trend.

Smarter trading The art of day trading Trading Chaos Sane Investing In An Insane World
Beat The Odds In Forex Trading Robert Kiyosaki - Rich Dad, Poor Dad
The Five Rules For Successful Stock Investing Joe DiNapoli - Trading with DiNapoli Levels