Alexander Elder

Introduction

Alexander Elder, a professional trader and psychiatrist, is best known for his disciplined approach to trading, which combines technical analysis, psychology, and risk management. His philosophy emphasizes that successful trading requires emotional control, systematic analysis, and strict adherence to rules. In Trading for a Living, Elder argues that the markets are driven by crowd psychology, and traders must separate themselves from the herd by following a structured method. His work focuses on eliminating common pitfalls—like overtrading or ignoring risk limits—while providing tools like the Triple Screen System and the Impulse System to identify high-probability trades.

The Triple Screen Trading System

Elder’s Triple Screen System is designed to minimize conflicting signals by analyzing the market across three timeframes: long-term, medium-term, and short-term.

1. Long-term (trend direction): The first screen uses a weekly chart to determine the broader trend. If the weekly trend is up, the trader looks for buying opportunities; if down, they seek selling opportunities. Elder emphasizes that trading in the direction of the long-term trend increases the odds of success.
2. Medium-term (timing): The second screen shifts to a daily chart, using an oscillator (like MACD-Histogram) to identify pullbacks against the long-term trend. For example, in an uptrend, the trader waits for the oscillator to dip into oversold territory before considering a long entry.
3. Short-term (entry points): The final screen uses an intraday chart (e.g., hourly) to fine-tune entries. Here, Elder suggests tools like the Force Index or Elder-Ray to confirm the trade setup.

The system’s strength lies in its hierarchical approach: no trade is taken unless all three screens align. As Elder puts it, “Amateurs look for challenges; professionals look for easy trades.” The Triple Screen forces traders to wait for high-probability setups rather than chasing random price movements.

The Impulse System

The Impulse System is Elder’s trend-following method, combining moving averages with the MACD-Histogram to confirm trade entries.

• Moving averages: The system uses two exponential moving averages (EMAs)—typically a 13-day and a 26-day EMA—to identify the trend. When the shorter EMA is above the longer one, the trend is up, and vice versa.
• MACD-Histogram: This oscillator confirms entries by measuring momentum. For example, in an uptrend, the trader waits for the MACD-Histogram to turn positive (rising bars) after a pullback.

Elder warns against using the Impulse System in choppy markets: “Trade only when the market is clearly trending.” The system thrives in trending conditions but can generate false signals in sideways markets.

Elder-Ray: Measuring Buying and Selling Pressure

The Elder-Ray indicator consists of two components: Bull Power and Bear Power. These measure the ability of buyers and sellers to push prices beyond key levels.

• Bull Power: Calculated as the high of the bar minus a 13-day EMA, this shows how strongly buyers are dominating. A rising Bull Power confirms an uptrend.
• Bear Power: Calculated as the low of the bar minus the same 13-day EMA, this reflects selling pressure. Falling Bear Power suggests weakening downtrends.

Elder notes that divergences between price and Elder-Ray often signal reversals. For instance, if prices make a new high but Bull Power fails to confirm, it may indicate a weakening trend.

The Force Index: Combining Price and Volume

The Force Index is an oscillator that blends price movement and volume to gauge trend strength.

• Formula: It multiplies the day’s price change (close vs. previous close) by volume. A positive value suggests bullish momentum; negative values indicate bearish pressure.
• Use cases: Elder highlights its utility in confirming breakouts or spotting divergences. For example, a breakout with a rising Force Index is more credible than one with weak volume.

He cautions against over-reliance on any single indicator: “The market is always right, but it is not always fair.” The Force Index works best when corroborated by other tools.

Risk Management: The 2% and 6% Rules

Elder’s risk management framework is non-negotiable.

• 2% Rule: No single trade should risk more than 2% of the trading capital. This prevents catastrophic losses, even in a string of losing trades. Elder stresses that ignoring this rule can “deplete trading capital quickly, even with a high win rate.”
• 6% Rule: If monthly losses exceed 6%, the trader must stop trading for the rest of the month. This prevents emotional decision-making after a drawdown.

These rules enforce discipline: “The goal of a successful trader is to make the best trades. Money is secondary.”

Rules in Practice

Elder’s trading rules are designed to counteract common pitfalls:

1. Always use stop-loss orders: Emotional exits often come too late. A pre-defined stop-loss removes subjectivity.
2. Never risk more than 2% per trade: This limits the damage from inevitable losing streaks.
3. Never meet a margin call: Reducing position size is safer than injecting more capital into a losing trade.
4. Never overtrade: Chasing trades out of boredom or frustration leads to poor decisions.
5. Never add to a losing position: Averaging down magnifies risk. Elder calls this a “common mistake.”
6. Trade only in clear trends: The Triple Screen and Impulse System both rely on trending conditions.

Lessons and Mistakes

Elder’s lessons stem from observing trader psychology:

• Adding to losers: Traders often double down on losing positions, hoping for a reversal. This violates the 2% Rule and can lead to ruin.
• Overtrading: After losses, traders may increase activity to “make it back fast.” Elder warns this compounds errors.
• Ignoring stops: Letting losses run “can result in catastrophic losses” when emotions override logic.
• Violating risk limits: Even a high win rate means little if a few bad trades wipe out gains.

As Elder puts it: “The only way to learn trading is by trading”—but only if done with strict rules.

Conclusion

Alexander Elder’s method is rooted in discipline, systematic analysis, and stringent risk management. From the Triple Screen to the 2% Rule, his framework targets the psychological traps that derail most traders. By focusing on high-probability setups and cutting losses quickly, his approach offers a blueprint for navigating the markets without succumbing to the crowd’s emotions. As Elder reminds readers: “Losers get high from the action; the pros look for the best odds.”