The Forex Index is a technical indicator that uses price and volume to measure the force, or the power, of bulls behind particular market rallies and of bears behind every decline. The indicator was developed by Alexander Elder, and was introduced in his classic book, Trading for a Living.
According to the concept given in his book, three essential components are included in the force index, which are the direction of price change, the extent of the price change and the trading volume. When the force index is used in conjunction with a moving average (MA), the resulting figure can accurately measure significant changes in the power of bulls and bears. In this way, Dr Elder has taken an extremely useful solitary indicator, the moving average, and combined it with his force index for even greater predictive success.
Calculation
The following equations are “Force Index (1)” and “Force Index (13)”:
– Force Index (1) = {Close (current period) – Close (prior period)} x Volume
– Force Index (13) = 13-period EMA of Force Index (1)
Calculation of the 1-period Force Index, which is straightforward, is 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 Force Index for more than one day is simply an exponential moving average of the 1-period Force Index. For example, a 13-period Force Index is a 13-period EMA of the 1-period Force Index values for the last 13 periods.
Interpretation
As mentioned above, three elements are associated with the Force Index. First, there is either a positive or negative price change. A positive price change signals that buyers were stronger than sellers, while a negative price change signals that sellers were stronger than buyers.
Second, there is the extent of the price change, which is simply the current close less the prior close. The “extent” shows us just how far prices moved. A big advance shows strong buying pressure, while a big decline shows strong selling pressure.
The third and final one is volume, which, according to Elder, measures commitment. A big advance on heavy volume shows a strong commitment from buyers. Likewise, a big decline on heavy volume shows a strong commitment from sellers.
In conclusion, these three elements are quantified into one indicator – the Force Index, which accesses buying and selling pressure.
Trend Identification
The Force Index can be used to reinforce or determine the trend. With the default Force Index parameter, which is 13, a resistance breakout in late-February on the 13-day Force Index corresponds to a resistance breakout on the price chart. Likewise, a support breakout on the price is reflected by a support breakout in early-August on the 13-day Force Index.
Divergences
Bullish and bearish divergences can give investors a signal of a potential trend change. Divergences are classic signals associated with oscillators. A bullish divergence forms when the indicator moves higher as the security moves lower. The indicator is not confirming weakness in price and this can foreshadow a bullish trend reversal. A bearish divergence forms when the indicator moves lower as the security moves higher. Even though the security is moving higher, the indicator shows underlying weakness by moving lower. This discrepancy can foreshadow a bearish trend reversal.
Conclusion
The Force Index is an indicator that uses both price and volume to measure buying and selling pressure. The price portion covers the trend, while the volume portion determines the intensity. Normally, investors can use it to identify the possible trend of the price, and take an action in advance when there is a divergence. As with all indicators, traders should use the Force Index in conjunction with other indicators and analysis techniques.