The Money Flow Index (MFI) tracks the flow of money into or out of a market. Price typically follows MFI and will eventually move in the same direction.
MFI is a volume-weighted relative strength index (RSI). It is effective for both stock and company selection because it gives a view of a market’s essential strength or weakness. Normally, MFI shows the same trends as the price pattern, indicating that, in an uptrend, money is flowing into the market, and when prices fall, money is flowing out of the market. Like the RSI, the MFI is measured on a 0 – 100 scale.
What the Money flow Index does ?
The MFI can be interpreted much like the RSI in that it can signal divergences and overbought/oversold conditions. It should be used as a secondary or supporting indicator.
Use in Trend Analyzer
The Money Flow Index is applied through the Indicator Menu. By default, four lines are plotted:
1. Money Flow Index (default 14)
2. Exrtreme High (default 60)
3. Mid Point (default 50)
4. Extreme Low (default 40)
The Extreme High, Mid Point & Extreme Low lines are stratight lines.
It is possible to plot upto two moving averages of MFI. Any of the lines can be removed by unchecking it.
[In Profit Tests, it is possible to test a trading strategy using the Money Flow index. MFI is included in the Momentum Trend group.]
Basic Rule
If a new price high is confirmed by a new indicator high it means that the bullish trend is strong;
If a new price bottom is confirmed by indicator bottom is means that the bearish trend is strong;
Bearish divergence warns of the weakness of the uptrend.
Bullish convergence warns of the weakness of the downtrend.
Divergences
Positive and negative divergences between the stock and the MFI can be used as buy and sell signals respectively, for they often indicate the imminent reversal of a trend. If the stock price is falling, but positive money flow tends to be greater than negative money flow, then there is more volume associated with daily price rises than with the price drops. This suggests a weak downtrend that threatens to reverse as money flowing into the security is “stronger” than money flowing out of it.
Overbought/Oversold
As with the RSI, the MFI can be used to determine if there is too much or too little volume associated with a security. A stock is considered “overbought” if the MFI indicator reaches 80 and above (a bearish reading). On the other end of the spectrum, a bullish reading of 20 and below suggests a stock is “oversold”.
Tips & Tricks
1. The MFI can be used to replace the RSI in your trading strategies.
Advanced Ideas
1. Like the RSI, the MFI can also be used as a trend indicator. Above 40, the trend is up. Above 60, there is a strong up trend. Below 40, the trend is down. In this method, the absolute value of the MFI is significant and not its direction.
Formula
The “flow” of money is the product of price and volume and shows the demand for a security and a certain price. The money flow is not the same as the Money Flow Index but rather is a component of calculating it. So when calculating the money flow, we first need to find the average price for a period. Since we are often looking at a 14-day period, we will calculate the typical price for a day and use that to create a 14-day average.
Typical Price = ( (Day High + Day Low + Day Close) / 3)
Money Flow = (Typical Price) x (Volume)
The MFI compares the ratio of “positive” money flow and “negative” money flow. If typical price today is greater than yesterday, it is considered positive money. For a 14-day average, the sum of all positive money for those 14 days is the positive money flow. The MFI is based on the ratio of positive/negative money flow (Money Ratio).
Money Ratio = (Positive Money Flow / Negative Money Flow)
Finally, the MFI can be calculated using this ratio:
Money Flow Index = 100 – (100 / (1 + Money Ratio))
The fewer number of days used to calculate the MFI, the more volatile it will be.
