Key Things to Consider
This is again a Bill Williams indicator and it is a blend with the Volume indicator. That being said, it should be noted that it has two main inconveniences:
– it repaints. This means that if you find a code/key into taking a trade with this indicator, then it should be noted that you cannot go back in history and test it as it is showing nothing but fake signals, as they are repainted. In other words, without back-testing, the validity of any theory is questioned as it may be that it offers ten straight profitable trades, only for the next one hundred to be losers.
– the second thing to consider is the fact that, like any indicator where volume is incorporated, the volume is not the total volume the market has, but merely the volume offered by the broker where the analysis is being made.
After reading the two draw-downs from above, one may argue that the indicator is of no use. I have to disagree.
The indicator shows four possible different candles, having four different colors, and in combination of MFI (Market Facilitation Index) and volume. For example, if the MFI and Volume are both up, the candle is green, and, if the MFI is up and Volume is down, then the color of the candle is blue.
How to Use the MFI Indicator
It can be treated in two different ways to give very nice signals for trading the markets, both the currency and binary options markets:
– one would be to filter the signals only based on the MFI and Volume, when they are showing the same direction, and in this case to take a trade only when a green candle is posted on the indicator;
– the other way would be to look for a trade when both MFI and Volume are down, and this means when the candle is blue.
The Metatrader, the most powerful trading platform, is offering the MFI under the Indicators tab, then choosing Bill Williams and the Market Facilitation Index a window appears with the volumes and the color code that is used. These colors can be changed, it is not mandatory for them to stay the same, it is only the default setting the trading platform is offering.
Setting the Overbought/Oversold Line
The minimum level the MFI is showing is the zero line and only positive values are being showed by the candles that are being plotted below the chart.
Like it was the case with the Gator oscillator, one way to trade with the MFI is to use so called overbought and oversold levels but this is a bit tricky as, like mentioned in the previous educational project, we need to identify those levels.
The thing is that such levels are showed with a strong candle regarding if the move the market makes is a bullish of a bearish one, as the candles are tight to the volume. Therefore, going back in time and looking for historical levels is one way to go and then plot a horizontal line on the oscillator’s window. Call options should be traded on any candle that shows the volume going above that line and price is bearish, as it represents oversold territory, while the opposite is true as well: put options on a move higher in price but with a candle that goes above that line.
However, the amount traded/invested should take into account, again, the fact that this indicator is painting and it cannot be used on a constant basis as the sole factor that triggers the decision to trade.
When it comes to volume analysis, it should be coupled with something more as the information given by any one broker is not complete and it refers only to the data provided by the clients of that respective broker.
How to Build an Ideal Environment?
The ideal environment for the right trading decision is to couple the MFI indicator with another oscillator and then to look for divergences that come with strong volume (hence a big candle in the MFI) and then to act and trade. This way, the risk of repainting that is given by the MFI is going to be diminished by the divergence that is formed on the other oscillator.
As a rule of thumb, look for using as few indicators/oscillators as possible as the more you use, the more confusing the whole picture is going to be and mistakes are going to be made.