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THE AIR BAG: PROTECTION AGAINST DISASTER
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I have been driving a car for over 45 years and have never been in an accident that I have caused. From that history, you might conclude that I am or at least have been a careful driver and need limited protection from my own driving. During that same 45 years, I have been through the windshield twice in head-on collisions. In both cases, I was sitting in the right-front passenger seat and the driver had the car in the proper lane, at a speed that was lower than the limit. Both accidents were caused by drunken drivers going in the opposite direction in the wrong lane.

From these experiences, I would never consider buying a car that did not have dual air bags. Looking at my automobile background statistically, I don't need an air bag for my driving but rather for protection against drunken drivers. Sometimes the market acts like a drunken driver, and you need the protection of an air bag.

As further evidence of the need for an air bag for the stock market, we know that traders who have exited the market because they could not trade profitably have usually left because of a few big losses rather than many small losses. If you protect your trades carefully, you may have a long string of small losses without having to leave trading. We need an air bag to protect us against large losses.

Fortunately, the market gives us an excellent technique for placing life- and trade-saving losses. The market can be broken down into five different trading time frames that have a similar and constant relationship with each other. We start with the monthly time frame:

The Air Bag: Protection Against Disaster

Each month contains

4.3 weeks; each week contains 5 days; each day contains

5-6 trading hours; each trading hour contains 4 (15-minute) or 6 (10-minute) bars

Each time frame breaks down to approximately one-fifth of the next higher time frame and approximately five times the next lower time frame.

We place the air bag one tick above/below the high/low of the second bar back on one significantly higher time frame (or the next bar further back that has both a higher high and a higher low or a lower high and a lower low). (See Figure 6-9.)

This is our air bag protection. Its purpose is to protect us against a drunken market that is moving against us. Remember, it is not necessarily an entry signal; it is protection against major losses. If your air bag is a high, it is telling you that you do not want to be short if the market reaches that number. If your air bag is a low, it is telling you that you do not want to be long if the market goes down to that number.

The vast majority of times, you will get a reversal or an entry signal before the market reaches your air bag. It is there to keep you from making a catastrophic mistake by staying in the market too long.

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