Force Index Indicator: How to Use the Force Index
The Force Index indicator was developed by Alexander Elder in the book "Trading for a Living." It fluctuates above and below zero, providing information on the power of a price movement based on price direction, magnitude of movement and volume. The Force Index helps confirm trending price waves and corrections, and highlights potential price reversals. To use the Force Index effectively, traders should understand how the indicator works, its applications, as well as its strengths and weaknesses.
What is the Force Index?
The Force Index fluctuates above and below zero. The indicator is above zero when the price is above the prior close; it is below zero when the stock price is below the prior close. This occurs when the indicator is set to calculate Force Index value for each period. Typically the indicator is averaged over more than one price bar though.
Set the indicator to 13 periods and it will take an average reading of the Force Index values over 13 periods to creates a smoother average, and provide more useful information.
How far the indicator moves above or below zero is based on the magnitude of the price move (from the close of the last price bar) and the volume for that price bar. Large price moves on large volume create significant and noteworthy swings on the Force Index. A large move with little volume creates a smaller swing on the Force Index.
When there is little volume or price movement the Index oscillates around zero, showing the price has no well defined direction or power. Under most circumstances, trades are avoided when there is a lack of strong movement as indicated by the Force Index.
All chart created using http://www.StockCharts.com
Figure 1 shows how the Force Index acts. We see spikes on the indicator when large price movements on large volume occur. The Force Index (20) is the 20-period average of Force Index (1), and therefore creates smoother values and stays either above or below zero for longer stretches.
Be sure to also read our Visual Guide to 8 Candlestick Patterns Every Trader Must Know
Force Index Calculation
Here’s the calculation for the force index:
Force Index (1) = [Close (current period) – Close (prior period)] x Volume
Force Index (20) = 20-period Exponential Moving Average of Force Index (1)
A 13-period average highlights short-term trends, and is suitable for shorter-term traders. A 100-period Force Index average will highlight longer-term trends and is preferred by longer-term traders.
The Force Index is available on most trading platforms, such as ThinkorSwim, and a number of free online charting sites including FreeStockCharts.com and StockCharts.com.
How It's Useful
The Force Index has three primary uses: trending confirmation, isolating corrections within trends and highlighting underlying strength or weakness (divergence).
The indicator visually shows when a strong shift in buying or selling momentum occurs. When the Force Index clings to the zero line, there is little momentum and traders may want to stay on the sidelines instead of initiating trades.
When the Force Index moves forcefully below zero it shows strong selling pressure; when the indicator stays below zero it signifies a downtrend.
A forceful rise above zero on the indicator shows strong buying pressure; when the indicator stays above zero it signifies an uptrend.
Figure 2 shows a price range, uptrend and downtrend. When the indicator moves below its own small range created around the zero line, it signals the start of the price downtrend. When the indicator rallies back above zero it indicates the potential for a price uptrend.
Using trend identification and a short-term Force index, traders can find entry points into the trending move.
During an uptrend, buy when the 2-period Force Index drops below zero and then rallies back above zero.
During a downtrend, short-sell when the 2-period Force Index rallies above zero and then drops back below zero.
This will create a very active strategy. Increase the number periods on the Force Index to decrease the number of trading signals.
In Figure 3 a moving average (60) has been added to the chart to help highlight the trend, along with a 4-period Force Index. Alexander Elder recommended using a 22-day exponential moving average on the chart and a 2-period Force Index to isolate the trend and pullbacks. Traders will find that different combinations work better with different stocks and trading styles.
During an uptrend only long positions are taken when the Force Index moves back above zero (from below). A stop loss is placed immediately following the entry, just below the recent low. The trade is held until the trader receives an exit signal based on their own method, or the Force Index moves back below zero.
For a downtrend, only short positions are taken when the Force Index drops below zero (from above). A stop loss is placed immediately following the entry, just above the recent high. The short trade is held until the Force Index moves back above zero.
Divergence on the Force Index shows that either volume or the magnitude of price moves has slowed and therefore the trend may be weakening and vulnerable to a reversal.
Divergence is when the indicator and price are not moving in the same direction. For instance, the price is making new highs, but the indicator is making a lower high. Or price is making a new low but the indicator is making a higher low.
Figure 4 shows a “bullish divergence.” The price makes a new low (or similar low to the former), but the Force Index makes a higher low, showing that selling pressure is diminished and the price is vulnerable to a reversal higher.
Divergence is not a trade signal, nor does it provide good entry timing. It only alerts traders to the vulnerability of a reversal. Yet that reversal could take a long time to develop, or if momentum picks up again the reversal may not come at all. Another entry method must be used in conjunction with divergence to make it useful for trading purposes.
Force Index Limitations
The Force Index is prone to “whipsaws” which is when the indicator jumps back and forth across the zero line. If using the indicator for trade signals this can result in a number losing trades before a stronger price move develops.
Increasing the number of periods of the Force Index can help in this regard, but then entry and/or exit signals based on the signal will also be delayed.
The indicator accounts for volume, direction and the magnitude of price movements—all key components in trading—but it is still up to the trader to determine when to utilize the indicator’s signals for trading purposes.
Trend confirmation and divergence provide some analytical insight, but won’t always be accurate. Some other form analysis, another indicator or an entry and exit method must be applied to these concepts to make them tradeable.
Proponents of the Force Index
The creator of the indicator is Alexander Elder, a New York trader born in Leningrad. He has worked as a doctor, psychiatrist, and even taught at Columbia University. His medical and psychology background, coupled with decades of trading experience, give him a unique insight into developing trading systems and helping traders. More information is available at http://www.elder.com.
The Bottom Line
The Force Index is used in various capacities, including trend confirmation, trade signals within a trend and divergence. The indicator fluctuates above and below zero showing the force of the current price move based on direction, magnitude and volume. Since the indicator moves back and forth across the zero line it is prone to providing false signals. Using the indicator in conjunction with other indicators or price/trend analysis will help filter out some of the false signals, and will make divergences more tradeable.
Did you know that...
- While equities are popular for long-term investing due to their growth potential, a well-rounded long-term portfolio might also include bonds, real estate, and other asset classes?
- Educating yourself continuously, through books or courses, can bolster your confidence and reduce anxiety in decision-making?
- The "black monday" crash of 1987 saw global stock markets plummet by large percentages in a single day, emphasizing the interconnectedness of global financial systems?
- The 'random walk hypothesis' asserts that stock prices move randomly and cannot be predicted based on past price movements?
- The silver thursday crash of 1980, when the hunt brothers tried to corner the silver market, illustrates the peril of market manipulation and overexposure in a single asset?
Quotes of the Day:
- "Investing is not about being right all the time, it's about being profitable." - Michael Steinhardt
- "The best way to invest is to be a value investor. Buy something for less than it's worth." - Joel Greenblatt
- "The most important thing is to be able to manage risk." - Ray Dalio
- "The most important thing in investing is to have a plan and stick to it." - Peterffy Thomas
- "Investing is not about being a genius, it's about being disciplined." - Robert Rodriguez
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