Money Flow Index
The Money Flow Index is a momentum indicator that was developed by Colin Twiggs and is an enhancement of Marc Chaikin’s Money Flow Index.
In fact, the Money Flow Index is a volume-weighted version of the Relative Strength Index, but instead of measuring a security's price action relative to itself, it measures the volume.
The MFI was designed to quantify the amount of money flowing into or out of a stock, commodity or share. In addition, MFI is a valuable tool for detecting trend weaknesses and pattern reversals.
The design of the MFI was based on research findings demonstrating that buying opportunities were normally preceded by rising volume levels together with increases in the number of closes in the top half of the daily range. Likewise, selling opportunities were preceded by rising volume levels together with increases in the number of closes in the lower half of the daily range.
The Money Flow Index is strongly correlated with the Relative Strength Index in that both operate within a range between 0 and 100. The MFI registers an overbought condition or pending market top when it posts readings above 80. Likewise, the MFI flags potential market bottoms or oversold conditions when it registers readings of 20 or lower.
The Money Flow Index also has a tendency to track the market trend in the same way as price. As such, any emerging discrepancies between the MFI and price are indicative that a change in the current price direction is imminent. For instance, if price is rising but MFI has begun to drop, the probability of a price reversal is high.
Very simply and outlining the procedure only, the Money flow Index is calculated as follows. First the average price is determined which is then multiplied by Volume. A Money ratio is then calculated using the resultant value. Finally, the Money Flow Index is evaluated and ranged between 1 and 100.
The Money Flow Index is best used in the following ways to detect potential trading opportunities.
When Money Flow Index registers a value over 80 then this is selling signal especially if it retracts back below this value. Likewise, when the MFI records 20 or below then this is a buying opportunity especially if it rises back above this value.
If the Money Flow Index and the price action start to diverge with the MFI moving in the opposite direction to the price, then this can often be a leading indicator of a change in the current trend. As such, this is a strong indication that the price will reverse to follow the Money Flow Index in the very near future.
However, care must be taken when using this Money Flow Index because even though, for instance, the MFI may be registering an overbought condition, the market does not know this. As such, despite the MFI posting a value of 87, for example, the market could still rally higher by 100s of points whilst the MFI only records an increase of just a few points.