Elder Force Index - Strategy, Rules, Settings

Elder Force Index – Strategy, Rules, Settings

Professional traders know that the right trading tools are ones that enable you to enter the market at the right moment and exit at the right time — one such tool that comes to mind is the Elder Force Index. What do you know about this trading tool?

The Elder Force Index is a technical indicator that tracks the force driving price movements. It measures the power of the bulls behind a price rally and the power of bears behind a price decline. A rising force index above the zero line suggests rising bull power behind a rally, while a falling force index below zero suggests increasing bear power behind a price decline.

In this post, we will take a look at most of the questions you may have about the Elder Force Index: what it is, how it works, and how you can improve your trading strategies with it. Read on!

Key takeaways

  • Elder Force Index is a technical indicator that tracks the force driving price movements.
  • Measures the power of bulls behind price rallies and the power of bears behind price declines.
  • Considers three key elements of price movement: Size of price movements, direction of movements, and trading volume.
  • Values oscillate around a zero line.
  • Can be used to: confirm breakouts, identify emerging trends, spot corrections, and predict possible price reversals
  • We show you a backtested Elder Force Index strategy complete with trading rules and settings.
  • More top trading indicators if you click here.

What is the Elder Force Index in trading?

The Elder Force Index is a technical indicator that tracks the force driving price movements. It measures the power of the bulls behind a price rally and the power of bears behind a price decline. This momentum indicator considers the size of price movements, the direction of the movements, and the trading volumes, which, according to Elder, are the three key elements of the price movement.

With both the price and volume data, the indicator measures the direction and magnitude of a price change — its values oscillating around a zero line. A rising force index above the zero line suggests rising bull power behind a rally, while a falling force index below zero suggests increasing bear power behind a price decline.

The force index can help confirm a breakout, identify an emerging trend, spot corrections, and possibly predict a price reversal. It generates zero-line crossover signals, breakout signals, as well as bullish and bearish divergence signals.

Here’s an example of what the indicator might look like on a chart:

Elder force Index example
Elder force Index example

Elder Force Index trading strategy

Let’s backtest the strategy. We make the following trading rules:

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If we apply the trading rules on the past and present stocks in the S&P 500 from 1990 until today, we get the following equity curve (we allocate 20% of our equity to each position thus having max 5 positions at any time):

Elder Force Index trading strategy
Elder Force Index trading strategy

Trading performance metrics and statistics from inception until today (including 0.03% commissions per trade):

  • Number of trades: 2533
  • Average gain per trade: 0.42%
  • Annual returns: 4.9%
  • Win rate: 33%
  • Time spent in the market: 85%
  • Risk-adjusted return: 5.8%
  • Max drawdown: 50%

As you can see, the indicator does not perform exceptionally well. The win rate is very low, so you need to withstand many losers in a row—this backtest had 25 losers in a row!

This is the code we used for the backtest (Amibroker):

THIS SECTION IS FOR MEMBERS ONLY. _________________ BECOME A MEBER TO GET ACCESS TO TRADING RULES IN ALL ARTICLES CLICK HERE TO SEE ALL 400 ARTICLES WITH BACKTESTS & TRADING RULES

How does the Elder Force Index work?

The Elder Force Index works as a momentum indicator. It uses both price and volume data to measure the direction and magnitude of a price change. As a momentum oscillator, the indicator oscillates around a zero line, with rising values above the zero line showing that the bulls are in power and falling values below the zero line showing that the bears are dominating.

The indicator can help confirm a price breakout — when a breakout is followed by a spike or a breakout of the indicator in the direction of the price move, it typically suggests there is a corresponding force behind the price move. For instance, an upside breakout in price should be accompanied by a spike in the force index above the zero line.

Divergence signals in the indicator can be used to anticipate a price reversal. A bullish divergence occurs when the force index is making higher swing lows while the price is making lower swing lows, and it suggests that the price may soon reverse to the upside. A bearish divergence occurs when the force index is making lower swing highs while the price is making higher swing highs, and it suggests that the price may soon reverse to the downside.

Who created the Elder Force Index?

The Elder Force Index was created by Dr. Alexander Elder, who first introduced the indicator in the book he published in 1993 titled: “Trading for a Living”. One of Elder’s numerous bestselling books, the book is among the most popular trading books of all time.

Dr. Elder is a renowned expert in technical analysis and trading psychology. He is a professional trader and a teacher of traders, who has been in the trading game for more than four decades. He is also a practicing psychiatrist.

What are the key components of the Elder Force Index?

The key components of the Elder Force Index are as follows:

  • The current close price: This is the closing price of the current period. Whether it is higher or lower than that of the preceding period is key to the force index.
  • The prior close price: This is the closing price of the preceding period. Its position relative to the current period’s close is key to the index.
  • The difference between the closing prices: When this is positive, the force index will have a positive value, and when it is negative, the index will have a negative value. The size plays a huge role in the strength/magnitude of the force index.
  • The current trading volume: This multiplies the difference in closing prices to get the 1-period force index. It also plays a huge role in the strength/magnitude of the force index. The higher the volume, the stronger the force index.

How is the Elder Force Index calculated?

The Elder Force Index is calculated using this simple formula:

EFI (1) = (Closec – Closep) x Volumec

EFI (n-period) = n-period EMA of EFI (1)

Where:

  • EFI (1) = Elder Force Index for 1 period.
  • Closec = Current close price
  • Closep = Close period of the preceding period
  • Volumec = Current period’s volume
  • EFI (n-period) = an n-period Elder Force Index

As you can see, the calculation has two steps. The first step is to calculate a 1-period force index, which multiplies the price change from one period to the next by the volume of the current period. The second step is to smoothen the data with an n-period EMA. The default is a 13-period EMA, but the trader can change this to whatever they prefer. The higher the number of periods used, the smoother the indicator line.

What does a positive Elder Force Index indicate?

A positive Elder Force Index indicates that the price is making a rally and it is backed by the volume. Depending on the size of the positive force index value, the price could be making strong moves in the upward direction backed by huge trading volumes. This means that there is bull power behind the price rally. As the index keeps rising above the zero line, the price is likely to continue in that trend and keep moving higher. However, the trend could change if the price and the indicator diverge — the indicator stops rising while the price continues to rise.

What does a negative Elder Force Index mean?

A negative Elder Force Index means that the price is falling and it is backed by the volume. Depending on the size of the negative force index value, the price could be making strong moves in the downward direction backed by huge trading volumes. This indicates that there is bear power behind the price decline. As the index keeps falling below the zero line, the price is likely to continue in that trend and keep moving lower. However, the trend could change if the price and the indicator diverge — the indicator stops falling while the price continues to make lower lows.

How can traders use the Elder Force Index?

Traders can use the Elder Force Index to confirm a price move, especially a breakout. For instance, if a price that has been in a tight consolidation suddenly breaks out to the upside, the trader can check whether the move is accompanied by a spike or breakout in the force index above the zero line. If the breakout is to the downside, the spike in the force index would be below the zero line.

Traders can also use the divergence of the indicator from the price swings to anticipate a market reversal. If the price is making higher swing highs but the force index is making lower swing highs, there is a bearish divergence, so they can anticipate a price decline in the near future. Likewise, if the price is making lower swing lows but the force index is making higher swing lows, there is a bullish divergence, so they can anticipate a price rally in the near future.

How does the Elder Force Index help identify trends?

The Elder Force Index helps identify trends by confirming that a trend is backed by the corresponding market force. That is, it confirms whether an uptrend is backed by bull power and a downtrend is backed by bear power. It does this by showing that the indicator line is in phase with the price movement. If the price makes a rally in an uptrend, the indicator spikes in the upward direction (above the zero line). Similarly, if the price is in a decline, the indicator spikes in the downward direction — below the zero line.

What time frames work best for the Elder Force Index?

The time frames that work best for the Elder Force Index will depend on your trading style and strategy. If you’re a day trader, you may want to use an intraday time frame, such as the hourly 30-minute, or 15-minute time frame. But if you are a swing trader, higher timeframes like the 4-hourly and daily timeframes would concern you more. However, for whatever style of trading you are using, to know the best time frame for your strategy, you have to backtest different timeframes and choose the one that works best.

Can the Elder Force Index be used for day trading?

Yes, the Elder Force Index can be used for day trading if traded on the right intraday timeframe and your strategy has been proven to have an edge in the market you’re trading and on that timeframe. What matters is to have a robust strategy with clear entry and exit rules on a suitable timeframe. The strategy must have a positive expectancy. Otherwise, you will not make money. If everything ticks well, the Elder Force Index can work for day trading.

How does the Elder Force Index compare to other indicators?

Compared to other indicators, such as moving averages and the MACD, the Elder Force Index is a momentum oscillator that measures the direction and magnitude of price movements using the price and volume data. It can be used to identify short-term trends and price swings, unlike moving averages that can show long-term trends and also serve as dynamic support and resistance levels. The indicator is a bit similar to MACD because they both oscillate about a zero line, but they use different methods to measure market momentum.

What are the strengths of the Elder Force Index?

The strengths of the Elder Force Index include:

  • The indicator can help traders identify the direction and strength of a short-term trend, which makes it easier to trade with the trend.
  • It can be used to confirm a price breakout — a valid breakout should be accompanied by a spike in the Elder Force Index.
  • It can be used with other indicators or analysis tools to identify entry and exit setups in the market.
  • It can also confirm signals generated by other technical indicators to make your trading decisions accurate.
  • Its divergence signals may be used to anticipate price reversals

What are the weaknesses of the Elder Force Index?

The weaknesses of the Elder Force Index include:

  • Lags a lot: Since the indicator uses an n-period EMA in its calculation, it can lag the price by a lot, depending on the length of the EMA period. As such, the indicator may not provide timely entry or exit signals. This may lead to missed opportunities or late exits.
  • False signals: When a short-period EMA is used to reduce lagging, the indicator becomes very sensitive to market noise and frequently generates false signals. This is especially true in choppy or sideways markets.

How do volume and price affect the Elder Force Index?

Volume and price affect the Elder Force Index in very significant ways as both data are used in the calculation of the indicator. How the current price closes relative to the preceding period’s close determines the direction of the indicator and also affects its magnitude. If over the last n-periods, the price has been closing higher than the preceding period, the indicator will be above the zero line and keep rising. The magnitude of the rise will depend on the size of the price gains and the volume. The greater the volume, the bigger the rise.

What is the best period setting for the Elder Force Index?

The best period setting for the Elder Force Index will depend on your strategy, how you want to use the indicator, and how sensitive you want it to be. If your strategy is to use the indicator to identify trends, you may want to set the period higher than the 13-period default setting. But if you want to use it as an oscillator to identify entry points while using other tools to find the trend, you may use a smaller-period setting.

How can the Elder Force Index confirm market reversals?

The Elder Force Index can confirm market reversals when its movements diverge from price swings. If the price is making higher swing highs but the force index is making lower swing highs, there is a bearish divergence, which could indicate a potential downward reversal. Likewise, if the price is making lower swing lows but the force index is making higher swing lows, there is a bullish divergence, which suggests a potential upside reversal.

Can the Elder Force Index be combined with other indicators?

Yes, the Elder Force Index be can combined with other indicators to improve its signals. It is important to combine it with complementary indicators, such as moving averages. You can use a long-term moving average to identify the main trend and potential support/resistance levels and then use the Elder Force Index to find entry points in the direction of the trend.

How does the Elder Force Index react to volatile markets?

How the Elder Force Index reacts to volatile markets will depend on its period settings. If the indicator’s period setting is small, it will be very sensitive to volatile markets. However, if the settings are long, the indicator will be less reactive to price changes in volatile markets.

What are common mistakes when using the Elder Force Index?

The common mistakes when using the Elder Force Index include:

  • Using the indicator without having a reliable trading strategy.
  • Not backtesting the strategy to know if it has an edge in the market you intend to trade
  • Trading without an adequate risk management plan
  • Trading in all market conditions with the same settings

How does the Elder Force Index differ from moving averages?

The Elder Force Index differs from moving averages in that it is a momentum indicator that uses price and volume data to estimate the direction and magnitude of price change, while moving averages simply calculate the average price over a given period. Moving averages may serve as dynamic support and resistance levels, but the Elder Force Index, being an oscillator, can not.

How can beginners start using the Elder Force Index?

To start using the Elder Force Index, beginners should study the indicator first to know how it works so they can create reasonable trading strategies with it. When they are able to do that, the next step should be to open a demo account and practice their strategies. They should practice until they can easily formulate, backtest, implement, evaluate, and optimize strategies that are based on the indicator.

What does a high Elder Force Index value suggest?

A high Elder Force Index value suggests that, over the last n-periods, the price has been closing higher than the preceding period with huge gains and that the trading volumes have been huge during those trading periods. The more the gains and the higher the trading volumes, the higher the Elder Force Index value, which suggests bull power.

What does a low Elder Force Index value mean for traders?

For traders, a low Elder Force Index value means there is bear power in the market. The low value implies that, over the last n-periods, the price has been closing lower than the preceding periods with huge losses and that the trading volumes have been huge during those periods. The more the losses and the higher the trading volumes, the lower the Elder Force Index value.

How can you customize the Elder Force Index for your strategy?

To customize the Elder Force Index for your strategy, you have to backtest the strategy with different settings and on different markets. This way, you can find the settings that work best for your strategy and the markets that offer the best results. Then, you use those settings for your strategy and focus your trading on those markets.

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