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Money Flow

What is Money Flow

Money flow is calculated by averaging the high, low and closing prices, and multiplying by the daily volume. Comparing that result with the number for the previous day tells traders whether money flow was positive or negative for the current day. Positive money flow indicates that prices are likely to move higher, while negative money flow suggests prices are about to fall. The below example shows negative money flow between Day One and Day Two:

BREAKING DOWN Money Flow

Positive money flow occurs when a stock is purchased at a higher price (an uptick). Negative money flow occurs when the next trade is purchased at a lower price (a downtick).

If more shares were bought throughout the day on the uptick than the downtick, net money flow is positive because more investors were willing to pay a premium for the stock. If money flow is negative when a stock’s price is rising, this could indicate a pending price reversal. Investors monitor money flow because trading volume is typically considered to lead price, which could help identify early trading opportunities. (For more, see: Why is the Money Flow Important for Traders and Analysts?)

Money Flow and Money Flow Indicators

Many traders use the Chaikin money flow oscillator when they want to incorporate money flow into their trading decisions. The indicator, created by Marc Chaikin, produces values for buying and selling pressure like other money flow indicators but also uses two exponential moving averages to determine momentum in a similar way that the moving average convergence divergence (MACD) indicator does.

Traders also frequently use the money flow index (MFI) when they want to analyze price and volume. This indicator divides the net positive money flow by the net negative money flow and plots the value as a line that traders can compare to the price of a security to identify overbought and oversold levels. If the indicator is above 80, prices are considered overbought. A value below 20 indicates oversold conditions.

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Other technical indicators should be used in conjunction with money flow indicators to improve their effectiveness and reduce false trading signals. (For further reading, see: What’s the difference between Chaikin Money Flow (CMF) and Money Flow Index?)

Money Flow Index (MFI)

Table of Contents

Money Flow Index (MFI)

Introduction

The Money Flow Index (MFI) is an oscillator that uses both price and volume to measure buying and selling pressure. Created by Gene Quong and Avrum Soudack, MFI is also known as volume-weighted RSI. MFI starts with the typical price for each period. Money flow is positive when the typical price rises (buying pressure) and negative when the typical price declines (selling pressure). A ratio of positive and negative money flow is then plugged into an RSI formula to create an oscillator that moves between zero and one hundred. As a momentum oscillator tied to volume, MFI is best suited to identify reversals and price extremes with a variety of signals.

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Calculation

There are several steps involved in the Money Flow Index calculation. The example below is based on a 14-period Money Flow Index, which is the default setting in SharpCharts and the setting recommended by the creators.

First, notice that Raw Money Flow is essentially dollar volume because the formula is volume multiplied by the typical price. Raw Money Flow is positive when the typical price advances from one period to the next and negative when the typical price declines. The Raw Money Flow values are not used when the typical price is unchanged. The Money Flow Ratio in step 3 forms the basis for the Money Flow Index. Positive and Negative Money Flow are summed for the look-back period (14) and the Positive Money Flow sum is divided by the Negative Money Flow sum to create the ratio. The RSI formula is then applied to create a volume-weighted indicator. The table below shows a calculation example taken from an Excel spreadsheet.

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Click here for an MFI calculation in an Excel Spreadsheet.

Interpretation

As a volume-weighted version of RSI, the Money Flow Index (MFI) can be interpreted similarly to RSI. The big difference is, of course, volume. Because volume is added to the mix, the Money Flow Index will act a little differently than RSI. Theories suggest that volume leads prices. RSI is a momentum oscillator that already leads prices. Incorporating volume can increase this lead time.

Quong and Soudack identified three basic signals using the Money Flow Index. First, chartists can look for overbought or oversold levels to warn of unsustainable price extremes. Second, bullish and bearish divergence can be used to anticipate trend reversals. Third, failure swings at 80 or 20 can also be used to identify potential price reversals. For this article, the divergences and failure swings are be combined to create one signal group and increase robustness.

Overbought/Oversold

Overbought and oversold levels can be used to identify unsustainable price extremes. Typically, MFI above 80 is considered overbought and MFI below 20 is considered oversold. Strong trends can present a problem for these classic overbought and oversold levels. MFI can become overbought (>80) and prices can simply continue higher when the uptrend is strong. Conversely, MFI can become oversold ( 90). Consider this a starting point for further analysis and due diligence.

For more details on the syntax to use for Money Flow Index scans, please see our Scanning Indicator Reference in the Support Center.

Money Flow Index (MFI)

  • Technical analysis
  • Technical indicators
  • Technical analysis
  • Technical indicators

Description

The Money Flow Index (MFI) is a momentum indicator that measures the flow of money into and out of a security over a specified period of time. It is related to the Relative Strength Index (RSI) but incorporates volume, whereas the RSI only considers price. The MFI is calculated by accumulating positive and negative Money Flow values (see Money Flow), then creating a Money Ratio. The Money Ratio is then normalized into the MFI oscillator form.

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How this indicator works

  • Oversold levels typically occur below 20 and overbought levels typically occur above 80. These levels may change depending on market conditions. Level lines should cut across the highest peaks and the lowest troughs. Oversold/Overbought levels are generally not reason enough to buy/sell; and traders should consider additional technical analysis or research to confirm the security’s turning point. Keep in mind, during strong trends, the MFI may remain overbought or oversold for extended periods.
  • If the underlying price makes a new high or low that isn’t confirmed by the MFI, this divergence can signal a price reversal.

Calculation

The Money Flow Index requires a series of calculations.

  • First, the period’s Typical Price is calculated.
    Typical Price = (High + Low + Close)/3
  • Next, Money Flow (not the Money Flow Index) is calculated by multiplying the period’s Typical Price by the volume.
    Money Flow = Typical Price * Volume
  • If today’s Typical Price is greater than yesterday’s Typical Price, it is considered Positive Money Flow. If today’s price is less, it is considered Negative Money Flow.
  • Positive Money Flow is the sum of the Positive Money over the specified number of periods.
    Negative Money Flow is the sum of the Negative Money over the specified number of periods.
  • The Money Ratio is then calculated by dividing the Positive Money Flow by the Negative Money Flow.
    Money Ratio = Positive Money Flow / Negative Money Flow
  • Finally, the Money Flow Index is calculated using the Money Ratio.

Money Flow calculates the typical price multiplied by volume.

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