Elder Force Index (EFI) Explained


“You can be free. You can live and work anywhere in the world. You can be independent from routine and not answer to anybody” - Dr. Alexander Elder, Trading for a Living

Introduction

The Force Index is an indicator that uses price and volume to assess the power behind a move or identify possible turning points. Developed by Alexander Elder, the Force Index was introduced in his classic book, Trading for a Living. According to Elder, there are three essential elements to a stock's price movement: direction, extent and volume. The Force Index combines all three as an oscillator that fluctuates in positive and negative territory as the balance of power shifts. The Force Index can be used to reinforce the overall trend, identify playable corrections or foreshadow reversals with divergences.

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Calculation

The force index is calculated by subtracting yesterday's close from today's close and multiplying the result by today's volume. If closing prices are higher today than yesterday, the force is positive. If closing prices are lower than yesterday's, the force is negative. The strength of the force is determined either by a larger change in price or a larger volume; either situation can independently influence the value and the change in force index.

The raw value of force index is plotted as a histogram, with the center line set to zero. A higher market will result in a positive force index, plotted above the center line; a lower market points to a negative force index, below the center line. An unchanged market will return a force index directly on the zero line. The raw line that is plotted over the day-to-day on the histogram forms a jaggedness and the moving average smoothes the line. Therefore, at minimum, you'll want to use a two-day exponential moving average (EMA) for the appropriate level of smoothing.

Calculation formulas:

Force Index(1) = {Close (current period)  -  Close (prior period)} x Volume
Force Index(13) = 13-period EMA of Force Index(1)

Interpreting the Force Index

In general, traders will want to buy when the two-day EMA of force index is negative and sell when it is positive. These traders, however, should always keep in mind the overarching principle of trading in the direction of the 13-day EMA of prices. The 13-day EMA of force index is a longer-term indicator, and, when it crosses above the centerline, the bulls are exerting the greatest force. When it is negative, the bears have control of the market. Of particular importance are divergences between a 13-day EMA of force index and prices, which correspond with precise points, indicating crucial turning points of the market.

As indicated by closing prices, the difference between yesterday and today's close gives the degree of the day-to-day victory of either the bulls or the bears. Similarly, volume is added into the calculation to give a greater sense of the degree of bulls or bears' victories. Volume also indicates the level of momentum in the market, as propelled by the power of either bulls or bears. Force index is one of the best indicators for combining both price and volume into a single readable figure. When force index hits a new high, a given uptrend is likely to continue. When force index hits a new low, the bears have greater strength and the downtrend will usually sustain itself.

A flattening force index is also an important situational circumstance for traders. A flattening force index means that the observed change in prices is not supported by either rising or declining volume and that the trend is about to reverse. On the opposite side of the matter, a flattening force index could indicate a trend reversal, if a high volume corresponds with only a small move in prices.

So, this is the basic manner in which force index can be used alone, or in conjunction with a moving average, to identify whether bulls or bears have control of the market. When volume is considered, an accurate sense of the market's momentum may also be quickly garnered.

Example

The All Ordinaries Index (Australia) is shown with 13-day exponential moving average (EMA) and Force Index.

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  1. A deep spike marks the end of a down-trend but it also warns traders to expect a re-test of the previous bottom.
  2. Go long [L] on the bullish divergence. Wait for the EMA to turn upwards.
  3. Declining peaks signal that bulls' strength is fading. No action is taken on the bearish divergence - the EMA is still rising.
  4. The Force index falling below zero indicates that the bulls have lost control. On the strength of the bearish divergence - go short [S] when the EMA turns downward.

Trend Identification

The Force Index can be used to reinforce or determine the trend. The trend in question, short-term, medium-term or long-term, depends on the Force Index parameters. While the default Force Index parameter is 13, chartists can use a higher number for more smoothing or a lower number for less smoothing. The chart below shows Home Depot with a 100-day Force Index and a 13-day Force Index. Notice how the 13-day Force Index is more volatile and jagged. The 100-day Force Index is smoother and crosses the zero line fewer times. In this regard, the 100-day Force Index can be used to determine the medium or long-term trend. Notice how a resistance breakout on the price chart corresponds to a resistance breakout on the 100-day Force Index. The 100-day Force Index moved into positive territory and broke resistance in mid February. The indicator remained positive during the entire uptrend and turned negative in mid May. The early June support break on the price chart was confirmed with a support break in the Force Index.

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Summary

The Force Index is uses both price and volume to measure buying and selling pressure. The price portion covers the trend, while the volume portion determines the intensity. At its most basic, chartists can use a long-term Force Index to confirm the underlying trend. The bulls have the edge when the 100-day Force Index is positive. The bears have the edge when the 100-day Force Index is negative. Armed with this information, traders can then look for short-term setups in harmony with the larger trend, such as bullish setups in a larger uptrend or bearish setups within a larger downtrend. As with all indicators, traders should use the Force Index in conjunction with other indicators and analysis techniques.


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