Market Facilitation Index (MFI) Trading Strategy – Rules, Returns, Performance

There are many technical analysis indicators available on many trading platforms for analyzing the markets, and one of them is the market facilitation index (MFI). What do you know about this indicator and how to use it?

The market facilitation index (MFI) is a technical indicator developed by Bill Williams for measuring the strength or weakness of the price trend. It uses volume to measure how strong or weak a price movement is. Traders can use it to determine whether a trend is strong enough for them to trade.

In this post, we take a look at the MFI, what it is, its components, how it is calculated, how it is used, and we show you a complete trading strategy with trading rules. Read on!

Key Takeaways

• The Market Facilitation Index (MFI) is useful for assessing price movements and trading volume to gauge market strength or weakness.
• MFI signals can help determine the right times to enter or exit trades by indicating whether a trend is gaining or losing momentum.
• The effectiveness of MFI varies with market conditions, requiring adjustments to trading strategies based on current market dynamics.
• It is advised to use MFI in conjunction with other indicators to avoid reliance on false signals and improve trade accuracy.

What is the Market Facilitation Index (MFI)?

The market facilitation index (MFI) is a technical analysis indicator developed by Bill Williams to measure the price movement relative to the volume traded over a chosen period. Bill Williams is the same man who made Bill Williams Awesome Oscillator indicator.

The Market Facilitation Index compares the price range over a timeframe with the trading volume during that period. Since the trading volume associated with a price move can indicate the strength or weakness behind the move, traders use the indicator to know whether a price move is healthy or not.

In popular trading platforms, such as the MT4, the indicator is presented as a multi-colored histogram in the indicator window. In the default mode, a green color bar shows a larger price range compared to the previous price bar and it’s accompanied by high volume; a brown color bar (often called a fade) shows both the price range and the volume are reduced; a blue bar (called a fake) shows that the price range increased while the volume reduced; and a pink bar (labeled squat) shows that the price range reduced while the volume increased.

As a technical trader, you can use the MFI to decide when a price trend is strong enough for you to consider trading it. It can also tell you when a new trend may be about to start so you can take a position and when the trend is nearing its end so you may get out of your position.

Market Facilitation Index (MFI) strategy – rules, backtest, returns, and performance

Now that you know what the indicator is all about, let’s backtest a specific trading strategy complete with trading rules.

These are the trading rules:

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We employ the trading rules on the S&P 500 (SPY) from its inception until today and get the following equity curve (x-axis shows # trades):

Here are some performance metrics and statistics:

• Total Trades: 806
• Time Spent In The Market: 52.50%
• CAGR: 5.19%
• Win Rate: 56.45%
• Average Win: 1.25%
• Average Loss: -1.28%
• Max Drawdown: -31.31%

Can the strategy be improved? Of course. We need to add one condition to the buy signal:

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Here is the new and improved equity curve:

The new performance metrics and statistics read like this:

• Total Trades: 358
• Time Spent In The Market: 25.95%
• CAGR: 4.71%
• Win Rate: 59.22%
• Average Win: 1.24%
• Average Loss: -1.12%
• Max Drawdown: -9.81%

We also make a sensitivity (optimization) backtest:

Market Facilitation Index trading strategy code

If you are a Python coder, we provide you with the complete Python code for the Market Facilitation Index strategy:

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How does MFI measure market activity?

The MFI measures market activity by comparing how much the price has moved to the total volume traded during the timeframe to get the market facilitation value. In other words, it looks at changes in the size of price moves and checks whether the trading volume is rising or falling during that period.

In simple terms, the MFI finds the price range over a given timeframe and divides it by the trading volume over that period. This value tells how much volume is involved in the price movement over that timeframe, which could be an hour, 15 minutes, a day, or even a second.

Why is MFI important in trading and finance?

The MFI is important in trading and finance because it can tell whether the trend is healthy enough for you to trade it. It uses both the trading volume and price range over a period to show the activity in the market. As you know, the trading volume should increase when the market activity is high.

If this happens when the market is trending in one direction, it shows that more traders trade in the direction of the trend. On the other hand, if the market activity is low but the volume is high, the market may be accumulating or distributing in readiness for a reversal.

Basically, traders use it to know if the price trend is strengthening or changing direction so as to know whether to be in the market, exit the market, or avoid the market.

How does MFI help traders identify market trends?

The MFI helps traders identify market trends by showing the strength or weakness of a price movement over a specified timeframe. Depending on the trader’s preferred color coding, one can use the color of the indicator bar to know the state of the market trend.

In the default setting, when the indicator bar is green, it shows that the price movement is associated with a huge volume increase compared to the preceding bar. This can tell you whether a potential new trend is emerging. Similarly, a blue or pink indicator bar may signal that a potential reversal is around the corner. But you have to combine it with other indicators or price action analysis.

What are the components of the Market Facilitation Index?

The components of the market facilitation index are the price and volume. Specifically, the price component is the price range over the period (timeframe) under study. The price range refers to the size of price movement in a timeframe (High – Low).

The volume component calculates the total volume traded during the entire timeframe. This shows whether the price move that happened in that timeframe was accompanied by increasing volume or not.

How is MFI calculated?

The MFI is calculated with the simple formula:

MFI = (H – L) / V

Where:

H = the price high in a timeframe, say H1

L = the price low

V = total volume traded over the timeframe

From the formula above, the MFI is calculated in 2 stages. First, you calculate the price range during a specified timeframe. This is given as H – L. That is, High – Low. After getting the price range, then you proceed with the second stage, which is to divide the range by the volume traded during that period. The quotient gives you the value of the MFI for that period/timeframe.

What do high and low MFI values indicate?

High and low MFI values indicate the relative contributions of the price and volume components of the indicator. High MFI values indicate that there’s a huge price range and a small traded volume during the timeframe. In other words, the price move happened with a relatively small volume, which might mean that the move should not be trusted.

Low MFI values indicate that there’s a relatively small price range and a huge volume during the timeframe. That is, a relatively small price move happened on a huge volume, which might imply that a big price move may be coming soon.

How can traders interpret MFI signals?

Traders can interpret MFI signals by combining the indicator with what the price action is showing them. The indicator comes as a multi-colored histogram, and different colors can tell you if a trend is gaining or losing strength and whether it is worth trading.

In the default mode, a green color bar indicates a larger price range compared to the previous price bar and it’s accompanied by high volume. A brown color bar (often called a fade) indicates that both the price range and the volume are reduced. The blue bar (called a fake) shows that the price range increased while the volume reduced, while the pink bar (labeled squat) shows that the price range reduced while the volume increased.

What role does volume play in MFI analysis?

The role volume plays in MFI analysis is that of a denominator. So, for any given price range, the higher the volume, the lower the MFI, and the lower the volume, the higher the MFI. Since volume is an important measurable indicator in determining the strength of price moves, the trading volume can influence the price trend by either strengthening it or changing its direction.

This is why it is often used in combination with the MFI indicator to analyze what is happening in the market.

How does MFI differ from other technical indicators?

The MFI differs from other technical indicators in that it is a volume-based indicator that is also analyzed with volume. It shows four different market scenarios, depending on whether the MFI and the volume are increasing or decreasing. And, the four scenarios are color-coded in the histogram bars of the indicator.

Depending on the color of the bar printed, it can help you to determine whether the market is liquid or not and whether the different types of market players are active. In a scenario where the market activity drops, such as the fake (blue bar), the major market players may not be behind the price move and, as such, may not be worth trading.

What are the advantages of using MFI in trading?

There are a few advantages of using the MFI in trading. Here are some of them:

• You can use it to know when a trend is strong enough for you to safely enter a trade in the trend direction.
• It may also tell you when a new trend is forming.
• You can also use it to know when to avoid entering the market.
• It helps you to know if the market is liquid and the different types of market players that are likely active at that point in time.

How can traders use MFI to confirm price movements?

Traders can use MFI to confirm price movements by observing the color of the histogram bars and using it to analyze the price action. If there is a huge price bar and the indicator bar is green, it means that the price move occurred on a high volume compared to the preceding price bar. This can tell the trader that the trend is strong enough to consider taking a position.

On the other hand, if the huge price forms when the indicator bar is blue, it could mean that the price movement happened on a relatively lower volume compared to the preceding price bar, and thus, the move may not be healthy for the trend.

What are common misconceptions about MFI?

The common misconceptions about the MFI are as follows:

• The MFI can be used as a stand-alone indicator: Bill Williams advised against using the MFI alone. He recommended using it with the fractal or alligator indicator. Experienced traders can use it with price action analysis.
• The MFI is a market strategy: It is only an indicator. So, it must be combined with other indicators or price action analysis to get the best out of it.
• The MFI is the same as the money flow indicator: While both share the same abbreviation, MFI, they are different. Market Facilitation Index measures the strength of a price move and it’s presented as a multi-colored histogram. It is neither an oscillator nor shows oversold/overbought levels. The money flow index, on the other hand, is a momentum, volume-based oscillator that follows the principle of the RSI and shows oversold/overbought levels.

How do traders integrate MFI into their trading strategies?

To integrate the MFI into their trading strategies, traders combine the indicator with other trading indicators or price action analysis to develop unique trading strategies with clear entry and exit criteria, position sizing, and risk management plans.

The MFI, on its own, cannot be used to decide when to enter or exit a trade. It must be used with other analysis tools to have a better understanding of the market structure and price movements. Bill Williams recommends combining MFI with the fractal or alligator indicator or moving averages. Experienced traders may also combine it with price action analysis.

What are the limitations of MFI as an indicator?

The limitations of the MFI as an indicator includes:

• It can’t be used as a stand-alone indicator: The indicator cannot be used alone. It must be used with other indicators, such as the fractal or alligator indicator, or price action analysis by experienced traders.
• It does not tell you when to enter or exit a trade: The MFI is only an indicator, and as such, cannot tell when to enter or exit a trade. You must combine it with other indicators or price action analysis to formulate a clear trading strategy.

How do market conditions affect MFI accuracy?

Market conditions affect MFI accuracy by unduly affecting one of the components of the indicator (price range or volume) more than the other. For instance, if there’s high volatility in the market with little liquidity, the price range would be unusually high, while the trading volume would be small. This would lead to an unusually high MFI value.

On the other hand, during periods of tight consolidation with high liquidity (distribution or accumulation phase), the price ranges are small, while the trading volume can be quite high. Thus, the MFI value would be small.

What are some practical examples of using MFI in trading?

Here are some practical examples of using MFI in trading on the MT4 platform:

Example 1: A buy signal on XAUUSD.

The chart below is that of gold (XAUUSD). The MFI printed a pink bar during the beginning phase of the US session, at a level where the price was retesting the low made during the London/European session. A pink MFI bar indicates a smaller price range on a higher volume.

All those factors point to a bullish reversal, and the price bar is already bullish. A buy at the close of that bar with a profit target (TP) at the London session high gave a good 1:3RR trade.

Example 2: A sell signal on XAUUSD:

The chart below shows a sell signal that appeared in the same XAUUSD when the price reached the London session high (a continuation of the price action in the chart of example 1). The price was sharply rejected at the London high, forming a shooting star candle pattern.

At the same time, the MFI printed a pink bar, which implies that the volume is increasing while the bullish bars are shrinking. When you put all the 3 factors (a shooting star, a resistance level, and a pink MFI bar) together, there’s a reasonably high probability that the price would drop.

So, a sell trade at that level would be a good decision. The profit target would be the day’s low, but as a day trader, you may exit just before the market close with over 1:2 RR profit.

How does MFI contribute to risk management in trading?

The MFI does not directly contribute to your risk management in trading because it neither tells you how much position size to use, nor which level to keep your stop-loss order.

However, you can use it to formulate a reasonable trading strategy, and with the data from your strategy backtesting, you can know the right amount to risk per trade, determine the appropriate position size per trade, and find the right level for your stop-loss order.

What timeframe is suitable for MFI analysis?

Any timeframe may be suitable for MFI analysis. It all depends on your trading style. If you’re a day trader, the hourly timeframe or M15 timeframe is fine. If you are a swing trader, you may use the H4 timeframe or the daily timeframe. If you are a position trader, the daily or weekly timeframe may be fine.

How can traders avoid false signals with MFI?

To avoid false signals with the MFI, traders have to use the indicator to create a reliable trading strategy with an edge and not try to trade with the indicator alone. It’s their robust trading strategy with the right data — win rate, risk-reward ratio, and positive expectancy — that would ensure they trade with an edge and avoid avoidable false signals.

What are the key considerations when using MFI alongside other indicators?

The key considerations when using the MFI alongside other indicators include:

• Whether the indicators complement one another
• Whether the strategy created from the indicators has an edge
• Whether the market condition is suitable for the strategy

How does MFI adapt to different market environments?

The MFI does not adapt to different market environments on its own. It’s your job as a trader to adapt the indicator to the market environment you’re trading. If the market is trending, you may be looking at the aspects of the indicator that validate the strength of the trend, like the green bars. If the market is ranging, you look for the aspects of the indicator that signal a potential reversal (like the pink bars) at the boundaries of the range market.

What are the historical origins of the Market Facilitation Index?

The market facilitation index was created by trader and author Dr. Bill Williams in the 1990s and was first featured in his book, ‘Trading Chaos’, which was published in 1995.

How has MFI evolved over time in trading practices?

The MFI has evolved over time in trading practices, just as traders have evolved. In the past, the market was easier to trade and trades mostly used indicators to find their trading edge. Today, traders don’t trade with one indicator alone and thus, must combine the MFI with other tools to find the right edge in the market.

What resources are available for further learning about MFI?

Some of the resources for further learning about MFI are Bill Williams’ book, Trading Chaos, and financial websites like therobusttrader.com and quantifiedstrategies.com.