The Elder impulse system or EIS is a trading system named after its inventor Dr Alexander Elder. He was originally a psychiatrist and used these skills to understand trading psychology.
He has authored several bestselling books including Come into My Trading Room in which he introduced the Elder Impulse System. Elder is also known for developing many other trading techniques such as triple screen trading.
In financial markets, impulse refers to a strong movement in the direction of the prevailing trend. The idea of this trading system is to identify the point from where a trending market speeds up or slows down.
Identifying the impulsive points help the trader find the entry and exit levels and benefit from trading by following the trend.
How Does the Elder Impulse System Work?
The Elder Impulse System works by combining the trend direction and its momentum. For that, the system uses two technical indicators.
The first indicator is a 13-period EMA (Exponential Moving Average) and the second indicator is MACD (Moving Average Convergence and Divergence). The EMA is used to identify the trend direction while the MACD is used for measuring the momentum of the trend.
Moving average is a commonly used technical indicator that smooths out the price data by using constantly calculated average prices.
There are several types of moving averages, the EMA is more sensitive to the recent price action compared to the simple moving average. The EMA indicates a bullish trend when the price of an instrument remains above the EMA line. Likewise, the EMA indicates a bearish trend when the price of an instrument remains below the EMA line.
The MACD is a momentum indicator that also uses moving averages for its calculations. The MACD has two lines that are called the Signal line and MACD line. In addition to these lines, the MACD indicator also shows a histogram that graphs the changes between the MACD and Signal Line.
The Elder Impulsive system does not take the MACD and Signal lines into consideration and only uses the MACD histogram. The MACD histogram is created on a baseline. The bars above the baseline are colored green and indicate a bullish momentum. The bars below the baseline are colored red and indicate bearish momentum.
How to Read the Signal using the Elder Impulsive System?
The Elder Impulse System is used for both the bullish and bearish signals. The system indicates a bullish signal when the following two conditions are met
- The price of the instrument is above the EMA line
- The MACD histogram is green and above its baseline
To understand more about the bullish signal, take a look at the following chart. The area marked as 1 shows the period in which EUR/CAD pair is in the downtrend.
The pair is keeping below the moving average and the histogram is also below the baseline. The area marked as 2 shows when the pair finally closed above the EMA line. About the same time, the histogram also turned green and moved above the baseline. This led to another couple of candles closing above the EMA line and confirmed the bullish signal. Following the signal, a huge rally can be observed on the chart.
The system indicates a sell signal when the following two conditions are met
- The price of the instrument is below the EMA line
- The MACD histogram is red and below its baseline
To understand the implications of a bearish signal, take a look at the following chart. The area marked as 1 shows the EUR/JPY is rising while the histogram is green and the price is also keeping above the EMA line. Area 2 shows when the pair closed below the EMA line for the first time. Around the same time, the histogram starts to turn red and moved below the baseline. Then a couple of next candles also closed below the EMA line which confirmed the bearish signal. Following the bearish signal, a strong downwards move can be seen on the chart.
Finding the exit levels using the Elder impulsive system is also very simple. For buy trades, the simplest way to spot the exit level is when the current price moves below the EMA and the MACD histogram bars start to move below the baseline. Similarly, for the sell trades, the exit level comes when the price moves above the EMA line, and the MACD histogram bars also start to move above the baseline.
Elder Impulse System Indicator
The Elder impulse system is also available as a pre-programmed indicator on several trading platforms. The indicator eliminates the need to add the MACD and EMA on the chart. The indicator makes it easy to read the signals and identify the neutral spots by looking at the candlestick colors.
The EIS indicator generally colors the candlesticks in red, green, and blue. The color preference can be changed using the indicator settings. The green candlesticks represent the bullish period. The red candlesticks represent the bearish period while the blue candlesticks indicate a neutral phase.
On the following EUR/USD chart, the EIS indicator is applied which is showing candlesticks in three different colors. By default, the indicator uses the same parameters defined in the Elder impulse system. However, these parameters can be changed from the indicator settings.
Note: changing the indicator parameters will also alter the system’s performance.
Rules to Trade Using Elder Impulse System
The Elder impulsive system is a simple yet powerful trading system. However, like any other trading system, the EIS also requires a set of rules to buy or sell.
A buy signal typically occurs when the current price is above the EMA and the MACD histogram is above the baseline. However, before placing a buy trade a trader should also follow the two rules mentioned below for even better results.
- A minimum of two candles should close above the EMA line
- Histogram bars should be big enough to indicate a strong upwards momentum
Likewise, before placing a sell trade a trader should follow the two rules described below
- A minimum of two candles should close below the EMA
- Histogram bars should be big enough to indicate a strong bearish momentum.
The two candlesticks closing above or below the EMA provide an additional confirmation on the direction of the direction. Similarly, the bigger histogram bars indicate a strong momentum which ensures a timely exit from the trades.
The timeframe plays an important role in any trading system. The Elder impulse system works on any timeframe but to reduce the risk traders should never ignore the overall trend direction on a bigger timeframe.
Elder recommends first setting up the system using an intermediate timeframe and then multiplying that timeframe by 5 to get the long-term timeframe. For instance, you can use a 65-period EMA which is five times the original 13-period EMA. This will indeed provide a better sense of the market direction over a longer timeframe.
The rule to multiply the intermediate timeframe by 5 is not a clear-cut rule and the traders must also use their judgment to analyze the trend. Traders can also combine other indicators like the RSI and volume indicator with the Elder impulse system to establish the trend.