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COMBINING THE MFI WITH THE ELLIOTT WAVE
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As noted earlier, one of the key indicators we use in Profitunity trading is the Market Facilitation Index (MFI). This is a basic measure of how effectively the current trading volume is moving price through time. It is an indicator of tick (gas) mileage. The higher the MFI, the more the price changes for each unit of volume. We want our money invested in the market when the price is moving the fastest, giving us the maximum rate of return. The MFI (explained in Chapter 6) is the range divided by the volume, and the answer is compared to the previous time period. After working with this indicator for several years, we noticed that there was a different range in each of the Elliott waves.

Most traders, even professional Elliotticians, sometimes find counting the waves on a price chart quite frustrating. I sought a better, more convenient, more accurate, and less subjective measure to count the waves. My next idea was to calculate the MFI in each wave, by averaging the MFI bars and then comparing the different averages for the different waves. I found exactly what I had anticipated.

The average MFI was highest during wave 3. On wave 1 and wave 5, this average was less. It was clear that there was a divergence between the price at the end of wave 5 and the average MFI for wave 5. Although the price was higher at the end of wave 5 than at the end of wave 3, the average MFI for wave 5 was less, creating a divergence (Figure 7-16). This divergence became an advance indicator for the end of this impulse series and forecasted a change in trend. Having identified a set of parameters, we were then able to trade from them or build an indicator to identify this difference between the market facilitation in each wave. This has been done successfully with the MFI. The MFI is a true present-tense momentum indicator.

Most of the "off-the-shelf" indicators, such as stochastics, RSI, and so on, do not compare momentum. They compare the current price with the price x bars ago. They do not compare the

Prices

Figure 7-16 Average MFI divergence between wave 3 and wave 5.

rate of internal price action inside wave 5 to that inside wave 3. Therefore, the more traditional indicators used by traders today will not consistently show the end of a trend, the most crucial information in trading.

Tom Joseph, an excellent researcher in trading techniques, has generated a very effective momentum indicator. He takes a 35-bar moving average and subtracts it from a 5-bar moving average. This produces an oscillator that is programmable on most quote machines. The 5-period average smoothes and rep­resents the current strength of the market, and the 35-bar moving average indicates the momentum strength over a longer period. We have found that if we change the numbers to a 5- bar/34-bar (5/34) oscillator, we get an extremely close approx­imation of the difference found by the more laborious job of averaging the MFI for each wave.

For example, assume that you are currently in a wave 3. The 5-period moving average represents the rate of movement inside the wave 3. This rate of change, like the MFI, is moving faster than at any other time in the Elliott wave sequence. The 34-period moving average represents the rate movement or MFI inside waves 1 and 2. This rate of change is much slower than the 5-period rate, creating a large difference between the two moving averages. Wave 3 produces the highest peak in the 5/34 oscillator. Over the years, we have tinkered with this oscillator in a number of ways.

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