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Volume is often overlooked in technical analysis. However, volume contains fascinating information about the strength of the market feeling.
High volume combined with a strong price move shows us that more people and money are committed to the move. Low volume is a sign that a price move has less commitment and that the price could be ready to reverse.
In the article below I describe a trading strategy that uses volume for entries and exits and shows the results of the trading strategy on the S&P 500.
The Money Flow Index
The Money Flow Index (MFI) is a useful indicator that incorporates both price and volume data. It uses a formula similar to the RSI to create an oscillator. The oscillator ranges between 0 and 100 and provides an easy-to-read snapshot of the current market strength.
The MFI can be used for timing trade entries, taking profits and judging the strength of the market.
You MFI is just one of the technical indicators and chart patterns in my eBook, 21 More Technical Indicators. The eBook is available in the Amazon Kindle Bookstore, and you can find more information, Get Better Trading Results using Technical Indicators in Excel.
The MFI works particularly well for market timing. In this trading strategy, I am using MFI to enter trades in the direction of the dominant trend.
In this backtest, I am using the following criteria.
Trade Entry Criteria
- Enter Long when the MFI crosses above a set level, and the price is above the EMA.
- Enter Short when the MFI crosses below a set level, and the price is below the EMA.
I calculate the stop-loss, profit target and trailing stops as a multiple of the ATR.
- I divide the position into two parts. I close the first part when the price hits the first profit target. Once the first profit target is hit the second part is closed when either the second profit target is hit or the MFI is above 80 for long trades and below 20 for short trades.
I backtested the above trading strategy using a Tradinformed Backtest Spreadsheet. These spreadsheets are a good way to test many different types of trading strategy. The spreadsheet includes a number of different variables that can be easily optimized.
The variables used in the backtest are:
Long Trade Entry above MFI 40 line
Short Trade Entry below MFI 70 line
EMA Filter 50 Period
First Profit Target 6 * ATR
Second Profit Target 12 * ATR
Stop-Loss 8 * ATR
Trailing Stop 8 * ATR
Cost per Trade 0.6
The backtest was carried out on the S&P 500 daily timeframe. I tested the strategy from the start of 1984 to March 2015
|Gross Winning Trades||4516|
|Gross Losing Trades||-1689|
|Largest Winning Trade||322|
|Largest Losing Trade||-151|
|Days Trading Long||4333|
|Total Trading Days||7788|
|Average Length of Trade||83|
|Median Length of Trade||70|
|Max Length of Trade||386|
|Min Length of Trade||13|
The above results show that the trading strategy has been profitable over a long period of time. During this time the stock market has tended to go higher. This strategy has been profitable for long and short trades, although it has been more profitable for long trades.
The capital graph shows that the trading strategy has performed consistently over time.
In this YouTube video, I describe the trading strategy and give further information about the backtesting process.
More Trading Strategies
Check out my page on Trading Strategies for great ideas to improve and develop your trading strategies.