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FORCE INDEX
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Force Index is an oscillator developed by this author. It measures the force of bulls behind every rally and of bears behind every decline.

Force Index combines three essential pieces of market information — the direction of price change, its extent, and trading volume. It provides a new, practical way of using volume to make trading decisions.

Force Index can be used raw, but it works better if you smooth it with a moving average. Force Index smoothed with a short MA helps pinpoint entry and exit points. Force Index smoothed with a long MA reveals major changes in the force of bulls and bears.

How to Construct Force Index

The force of every move is defined by its direction, distance, and volume. If prices close higher than the previous bar, the force is positive. If prices close lower than the previous bar, the force is negative. The greater the change in prices, the greater the force. The bigger the volume, the greater the force of the move (see worksheet, Figure 42-1).

Force Index = Volume today • (Close today - Close yesterday )

Raw Force Index is plotted as a histogram, with a horizontal centerline at

a zero level. If the market closes higher, Force Index is positive and is plotted above the centerline. If the market closes lower, Force Index is negative and plotted below the centerline. If the market closes unchanged, Force Index equals zero.

The histogram of raw Force Index appears very jagged. This indicator gives better trading signals after being smoothed with a moving average (see Section 25). A 2-day EMA of Force Index provides a minimal degree of smoothing. It is useful for finding entry points into the markets. It pays to buy when the 2-day EMA is negative and sell when it is positive, as long as you trade in the direction of the 13-day EMA of prices.

A 13-day EMA of Force Index tracks longer-term changes in the force of bulls and bears. When it crosses above its centerline, it shows that bulls are

in control. When it turns negative, it shows that bears are in control. Divergences between a 13-day EMA of Force Index and prices identify important turning points.

Trading Psychology

When the market closes higher, it shows that bulls won the day's battle, and when it closes lower, it shows that bears carried the day. The distance between today's and yesterday's closing prices reflects the margin of victory by bulls or bears. The greater this distance, the more important the victory.

Volume reflects the degree of commitment by the mass of market participants (see Section 32). Prices moving at high volume are like an avalanche that gathers mass as it rolls. High-volume rallies and declines have more inertia and are more likely to continue. Low volume, on the other hand, shows that the supply of losers is running low and a trend is nearing an end.

Prices reflect what market participants think, while volume reflects their feelings. Force Index combines price and volume —it shows whether the head and the heart of the market are in gear with each other.

When Force Index rallies to a new high, it shows that the force of bulls is high and the uptrend is likely to continue. When Force Index falls to a new low, it shows that the force of bears is big and the downtrend is likely to per­sist. If the change in prices is not confirmed by volume, Force Index flattens out and warns that a trend is about to reverse. It also flattens out and warns that a trend reversal is near if high volume generates only a small price move.

Trading Rules

Short-Term Force Index

A 2-day EMA of Force Index is a highly sensitive indicator of the short-term force of bulls and bears. When it swings above its centerline, it shows that bulls are stronger, and when it falls below its centerline, it shows that bears are stronger.

A 2-day EMA of Force Index is so sensitive that it is best used to fine- tune signals of other indicators. When a trend-following indicator identifies

Figure 42-2 Force Index — 2-Day EMA

This sensitive short-term indicator pinpoints buying opportunities in uptrends and shorting opportunities in downtrends. It helps traders buy weakness and sell strength. When the trend, identified by the slope of the 13-day EMA, is up and Force Index declines below zero, it gives a buy signal. When the trend is down and Force Index rallies above zero, it gives a signal to sell short.

The decision when to take profits depends on whether you are a short-term or a long-term trader. If you are a short-term trader, sell longs when Force Index becomes positive or cover shorts when Force Index becomes negative. A long-term trader has to wait until the exponential moving average changes its direction or until there is a divergence between Force Index and price (marked by slanted arrows on this chart). When you are trading with the trend, you can add to your positions (pyramid) whenever Force Index gives additional signals in the direction of the trend.

an uptrend, the declines of the 2-day EMA of Force Index spot the best buying points. When a trend-following tool identifies a downtrend, a 2-day EMA of Force Index pinpoints the best shorting areas (Figure 42-2).

Buy when a 2-day EMA of Force Index turns negative during uptrends.

No matter how fast and furious an uptrend, there are always pullbacks. If you delay buying until the 2-day EMA of Force Index turns negative, you will buy closer to a short-term bottom.

When a 2-day EMA of Force Index turns negative during an uptrend, place a buy order above the high price of that day. If the uptrend resumes and prices rally, you will be stopped in on the long side. If prices continue to decline, your order will not be executed. Then lower your buy order to within one tick of the high of the latest bar. Once your buy stop is triggered, place a protective stop below the low of the trade day or the previous day, whichever is lower. This tight stop is seldom touched in a strong uptrend, but it gets you out early if the trend is weak.

2. Sell short when a 2-day EMA of Force Index turns positive in down
trends.

When trend-following indicators identify a downtrend, wait until the 2-day EMA of Force Index turns positive. It indicates a quick splash of bullish­ness—a shorting opportunity. Place an order to sell short below the low of the latest price bar.

If the 2-day EMA of Force Index continues to rally after you place your sell order, raise it daily to within a tick of the latest bar's low. Once prices slide and you go short, place a protective stop above the high of the latest price bar or the previous bar, whichever is higher. Move your stop down to a break-even level as early as possible.

A 2-day EMA of Force Index helps you decide when to pyramid your positions. You can add to longs in uptrends each time Force Index turns negative and add to shorts in downtrends whenever Force Index turns positive.

Force Index even provides a glimpse into the future. When a 2-day EMA of Force Index falls to its lowest low in a month, it shows that bears are strong and prices are likely to fall even lower. When a 2-day EMA of Force Index rallies to its highest level in a month, it shows that bulls are strong and prices are likely to rise even higher.

A 2-day EMA of Force Index helps decide when to close out a position. A short-term trader who buys when this indicator is negative should sell when it turns positive. A short-term trader who goes short when this indicator is positive should cover when it turns negative. A longer-term trader should get

out of his position only if a trend changes (as identified by the slope of a 13-day EMA of price) or if there is a divergence between 2-day EMA of Force Index and the trend.

•  Bullish divergences between 2-day EMA of Force Index and price
give strong buy signals. A bullish divergence occurs when prices fall
to a new low while Force Index makes a more shallow bottom.

•  Bearish divergences between 2-day EMA of Force Index and price
give strong sell signals. A bearish divergence occurs when prices rally
to a new high while Force Index traces a lower second top.

A 2-day EMA of Force Index fits well into the Triple Screen trading system (see Section 43). Its ability to find short-term buying and selling points is especially useful when it is combined with a longer-term trend-following indicator.

Intermediate-Term Force Index

A 13-day EMA of Force Index identifies longer-term changes in the strength of bulls and bears. Its position relative to its centerline shows which group is in control. Its divergences from prices identify major turning points (Figure 42-3).

5. When a 13-day EMA of Force Index is above the centerline, bulls are in
control of the market, and when it is below the centerline, bears are in
control. When this indicator flutters near its centerline, it identifies a
trendless market—a warning not to use trend-following trading methods.

When a rally begins, prices often jump on heavy volume. When a 13-day EMA of Force Index reaches a new high, it confirms the uptrend. When the uptrend ages, prices rise more slowly or volume becomes thinner. Then a 13- day EMA of Force Index starts tracing lower tops and eventually drops below its centerline. It signals that the back of the bull has been broken.

6. A new peak in the 13-day EMA of Force Index shows that a rally is
likely to continue. A bearish divergence between a 13-day EMA of
Force Index and price gives a strong signal to sell short. If prices reach
a new high but this indicator traces a lower peak, it warns that bulls
are losing power and bears are ready to take control.

Figure 42-3 Force Index — 13-Day EMA

Divergences between a 13-day EMA of Force Index and prices identify important turning points in the markets. A bullish divergence between a 13-day EMA of Force Index and the Nikkei Dow in August pointed to a buying opportunity. The Nikkei Dow retested its lows, but Force Index traced a much more shallow second bottom, giving a buy signal.

A spike low in Force Index, like the one seen in August, gives two trading messages. In the long run, it usually marks the end of an important decline. In the short run, it tells traders that the latest price bottom is likely to be retested or exceeded.

The Nikkei Dow surged higher in October, but Force Index kept tracing lower tops. Its bearish divergence showed that bulls were growing weak and prices neared a top. There was plenty of time to position short. The spike low at the right edge of the chart indicates that the latest price low is likely to be retested or exceeded.

7. A new low in 13-day EMA of Force Index shows that a downtrend is likely to continue. If prices fall to a new low but this indicator traces a more shallow low, it warns that bears are losing power. This bullish divergence gives a strong buy signal.

When a downtrend begins, prices usually drop on heavy volume. When a 13-day EMA of Force Index falls to new lows, it confirms the decline. As the downtrend grows old, prices fall more slowly or volume dries up. Then the 13-day EMA of Force Index starts tracing more shallow bottoms and finally rallies above its centerline. It shows that the back of the bear has been broken.

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