FOREX Trading Strategies
Trading with Indicators: The Force Index
This article has been written by Dr. Alexander Elder,
the Inventor of the Force Index.
One of my favorite market tools is an indicator you see on almost every chart I show – the Force Index. I invented it in the 1980s and have been using it ever since. In the days before computer (yes, that far back!) I used to calculate and plot it by hand. Now it is included in many trading packages and featured on every elder-disk. It is described in detail in Trading for a Living and all my other books. If your software does not include Force Index, you can easily program it and add it to your own package yourself.
Force Index works by linking market volume with price changes. Volume is hugely important – it is the steam that makes the choo-choo go – but an ordinary bar chart of volume is hard to read. Force Index, on the other hand, very clearly brings out the message of volume.
Here’s the Force Index formula and the two steps involved in calculating this indicator:
Force Index = (Closetoday – Closeyesterday) * Volumetoday
Force Index multiplies today’s volume by the difference between today’s and yesterday’s close. Since that difference might be positive or negative, the Force Index can be either positive or negative.
Even though the formula refers to ‘today’ and ‘yesterday’, we are not limited to using Force Index on the daily charts. We can use it with weekly, monthly, or intraday charts. A computer program does not count days – it counts bars. This is why we can use Force Index with any bar or candlestick chart.
Once we calculate the Force Index, we need to smooth it with a moving average. I like using a 13-bar EMA of Force Index to identify longer-term trends and a 2-day EMA of Force Index for shorter-term timing of entries and exits.
This daily chart of GOOG shows how the 13-day EMA of Force Index gives important buy and sell signals when it crosses its zero line. Even if you are a short-term trader looking to stay in a trade for only a few days, these crossovers in effect tell you: “Now is the time to look for long trades” or “Now is the time to look for short trades.” These signals remain in effect until the 13-day EMA of Force Index crosses its zero line in the opposite direction.
The stock market has enough opportunities to make your head spin. It also has enough dangers to catch all your fingers in the door. I value the 13-day EMA of Force Index because it tells me when to drive on this side of the road and and when to drive on the other side.
The 2-day EMA of Force Index is especially well suited for short-term timing. I often use it to decide when to take profits. Look at the A-B-C bearish divergences during the uptrend in October or at the A-B-C bullish divergence during the downtrend in February. These divergences sensitively pick up the points where the dominant trend becomes weak and ready to reverse.
An additional signal of a 2-day EMA of Force Index helps conservative traders enter positions. If you are looking to get long, it pays to buy when this indicator falls below zero, indicating a short-term imbalance – a buying opportunity. If you are looking to sell or sell short, this is best done when the short-term Force Index is above zero, marking an overvalued stock or any other trading trading vehicle.
These features make Force Index much clearer and easier to read than an ordinary volume chart.
Risk Disclosure: Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts.
Copyright 2013, FOREX MASTERS