- September 16, 2020
- Posted by: CoachShane
- Categories: Trading Article, Trading Indicators
The Force Index indicator is part of the family of oscillators that combines price and volume and helps to show turning points in the market.
This technical indicator was designed by Alexander Elder (sometimes called the Elder Force Index), to identify the force of the move and brings together three pieces of data:
- Direction of price change
- How big a price move it was in that direction
- Volume that occurred during that change
The Force Index has different smoothing settings for both short and long, for:
- Entry and exit points
- Confirm price trends
- Confirm important price reversals
The indicator can be used on any time frame that offers volume data as it is needed for the calculation. Forex traders, unless trading the futures contract, won’t get the full benefit of the indicator.
Force Index Formula
It is not a complicated formula compared to many indicators:
Volume * (Close Today – Close Yesterday)
That will give you a jagged reading as the output is a Force Index reading of 1.
In this example, our setting of 13 means: a 13-period EMA (exponential moving average) of the 1-period Force Index values from the previous days.
Alexander Elder recommends this setting to reduce the positive-negative crossovers however he does use a setting of 2.
In the graphic, we see the EFI line at different points in the window.
- + Force reading means that the closing price was higher than the previous close
- – Force reading is the closing price being lower than the the previous close
- Strong selling pressure will show an extreme reading to the downside
- Strong buying pressure with give you an extreme upside reading
The Force Index of 1 shows many crosses of the zero line and for some traders, that is too quick of a signal. Elder does recommend that traders test different settings depending on their approach to the markets.
Volume plays a big role in the indicator. When you get big increases in volume, you will see bigger moves with the Force Index. Low volume will equal smaller moves.
How To Use The Elder Force Index In Your Trading
Since the Force indicator is designed to show buying or selling pressure, there are three specific ways we can use it.
Remember that the indicator:
- Takes into account the difference between the prior close and current close. Did price close higher or lower than the previous day?
- Measures the extent of the difference in price between the two closes and that will influence the indicator reading
- Uses volume. Higher volume will show a commitment of either the buyers or sellers in that direction
Keep in mind that your market of choice must have a volume reading in order to fully utilize the indicator.
Trend Identification/Confirmation of Trend
Since the Force Index shows the strength of the buyers and sellers, it can show, depending on the setting, the direction of the momentum price trend.
Here is an example of a 13 period Force Index and and 90 day Force Index.
The differences may be subtle in some areas but looking at the ranges, you will see the 13 period crosses the zero line a bit earlier. This, depending how you trade with the overall trend, could get you in a trade while the market is in a range.
Once the EFI crosses the zero line, that could be a confirmation that the buyers or sellers are in control.
When reading the EFI, consider the direction the indicator is making :
- Indicator below zero line and moving downwards = Strong bearish trend and no buying allowed
- Indicator below zero and moving up = Tentative long positions/tightening of stops on short trades. Potential trend change coming.
- EFI above zero and climbing = Strong bullish trend and no shorting allowed
- Indicator above zero and falling = Tentative shorts and tighten stops on long positions. Potential trend change coming.
There are a few ways to interpret the indicator and the actions you could consider in certain states. Traders could also use a moving average such as the 50 period moving average on the price chart and use the EFI as trend confirmation.
Buying Pullbacks – Entry/Exit Indicator
The first step in using the indicator to buy or sell pullbacks is to determine the direction of the trend.
There are many ways to determine the trend direction including:
- Using a moving average on the price chart such as the 20 EMA, Elder suggested 22 period moving average, 50 EMA or longer
- Price action forms structures of higher highs and lows and lower highs and lows. Use that to determine trend
- Use a 13 period or longer Force Index
Trading corrections in the market is my favourite way to trade. Using a setting of 2 on the Force Index, will give you quick trade signals as the indicator is very sensitive to price changes.
Trading corrections is quite simple as you look for your trading signal:
- Trade only in the direction of your trend indicator
- In an uptrend, look for the a buy signal which is the Force Index dropping below zero. Place a buy stop order above the bar (candlestick) that turned the indicator
- Downtrends would look for the indicator to go above zero for a sell signal. You’d place an order to sell once the low of the bar (candlestick) is broken
If price keeps falling or rising, continue to move your entry order until you are filled or the trend changes. Stop loss will go under the most current low (if long) and high (if short).
As an added confirmation, look for pullbacks to terminate around support or resistance levels.
Trading Force Index Divergence
Trading a price divergence is a popular trading strategy when using oscillators and we can use the EFI to do exactly that.
Here is a quick primer on trading divergence:
- Bullish divergence – Oscillator makes a move higher while price action heads lower
- Bearish divergence – We have a move lower in the indicator but price has moved higher
Divergence can happen all over the chart so ensure you have some type of confirmation of the trend reversal: use price action, a confirming indicator, candlestick patterns.
I have highlighted a few on this daily chart of Amazon but divergence will apply to day trading as well. The indicator in this example is set to 2 periods.
Starting from the left side of the price chart:
- Price makes a slightly higher high while the indicator has a bearish divergence. No big trend change but you can see price action was not too exciting to trade.
- Price continues it’s upwards advance yet the indicator heads down. We do see the bearish divergence worked
- As of this writing, we have a bullish divergence put in as price put in a lower low yet the indicator gave a higher low
A longer or shorter period for the indicator may give you different points of divergence or none at all. I have found that there are times even with different settings, the change in the shape of the indicator is very subtle.
You will need to find a trade trigger, and entry point, to enter divergence setups. The easiest method is to use a trend line break as the entry location.
Force Index – The Bottom Line
Using price data from the current period and prior period, along with volume, makes this indicator something to experiment with. We have a combination of trend direction through the closing of price and the intent of buyers and sellers through the use of volume.
It can be made sensitive with a period 2 setting which is great for entry and exit signals.
Longer period settings would be good for trend following methods of trading.
Include other forms of technical analysis such as price patterns or other trading indicators to complete a full trading strategy.