The monthly cycle (4 week, 20 days), a dominant cycle that influences all markets, is also the best explanation for why the 4-week time period has proven so successful. The principle of harmonics in cyclic analysis holds that each cycle is related to the next longer or shorter cycle by 2.

Moving averages point out how the monthly cycle and harmonics explain the popularity of the 5-, 10-, 20-, and 40-day moving averages. With the weekly rule, the daily numbers are translated into weekly time periods of 1, 2, 4, and 8 weeks. So in keeping with harmonics, the 4-week rule can be adjusted by multiplying or dividing by 2. To shorten, go to 2 weeks, or shorten it again to make it even more sensitive by going to 1 week. To add time, multiply by 2 for 8 weeks. This method combines price and time, so the cyclic principles of harmonics can play an important role here.

The 4-week rule is a simple breakout system, but it works beautifully. The original rule can be modified to a shorter time of a 1 - 2 week rule for liquidation purposes, and a 2-week period will produce a more sensitive system for entry signals. Price channels can easily be plotted above and below the current prices using charting software packages to spot channel breakouts, and the price channels can be applied to daily, weekly, or monthly charts.

There are many adjustments and refinements that can be made to the 4-week rule. One such refinement is to utilize weekly signals merely as indicators, not a trading system, to identify breakouts and trend reversals. Weekly breakouts can be used as confirming filters for other techniques, like moving average crossovers. One or 2 week rules function as great filters. A two week breakout, in the same direction, can confirm a moving average crossover signal and prompt our trader to take a market position.

Lengthening or shortening the time period used will make a difference in risk management and sensitivity. Just as in the moving average, shortening the time period makes the rule more sensitive, as could be done when there's a relatively high priced market with prices trending sharply higher. Suppose our trader chooses to take a long position on a 4 week upside breakout with a protective stop placed just below the low of the past 2 weeks. Because the market rallied sharply, our trader will want to be more protective, so he uses a one week stopout point.

Conversely, in a trading range situation. the trend trader may prefer to wait on the sidelines until an important trend signal is given before committing to a position. In this case expanding the time period to eight weeks would prevent him from taking positions on shorter term and premature trend signals.

Andy Swan is co-founder and head trader for DaytradeTeam.com.  To get all of Andy's day trading, swing trading, and options trading alerts in real time, subscribe to a one-week, all-inclusive trial membership to DaytradeTeam by clicking here.