Greetings traders and welcome back to another In-Depth with
Chris episode. In today's discussion,
we will be covering the Money Flow Index. Sounds wonderful
because hey, it sounds like money is just flowing from a
stream. It's a little bit more complicated than that, but
it is an indicator that is quite fun to use, and as such, we
will be going into all of the details about how it works,
where it comes from, and how it can potentially be used as
a strategy to find signals.
Now, before we get going any further,
let's show you how you can apply it to your charts on the
Finamark platform. That way, you can follow along the entire
time. In order to do so, we're going to click the top center
"show indicators options" button,
and then we're going to add a new section.
It is not an indicator that overlays price directly,
so we got to add a new section.
And after we do that, when we scroll down to the "M"s , we will
see that there is a Money Flow Index. If we give that a click,
go back to our charts, we'll see that the Money Flow Index
has been added. I am just simply stretching it down a little bit lower,
so it takes up less of the screen, and that is all there is
to it. Without further ado, let's dive on into that material.
But please click that like and subscribe button down below
if you haven't already.
Let's dive on into that material and keep on going.
There are all types of trading indicators out there today
for traders to choose from to help them with their technical
analysis to better predict market movement.
The Money Flow Index has to be one of the coolest named indicators
that falls into one of the most widely used indicator groups
out there. That group is the oscillators category.
Everybody has heard of the RSI, but not many traders are
aware, or use, the Money Flow Index, not due to any problems
with the Money Flow Index, but instead due to the lack of
knowledge about it or how to use it.
The Money Flow Index is indeed an oscillator that is used
by technical traders to identify overbought and oversold
scenarios. The MFI for short is also applied by traders to
help spot divergences, trend reversals, and failure swings.
The indicator takes into account both price and volume information,
which is what makes it different from the majority of the
other oscillators out there, such as the Relative Strength Index,
which incorporates just price data. Analyst refer to
the MFI as a volume weighted RSI as a way of describing it.
The Money Flow Index is based on the idea that the volume
alone isn't indicative of the market's overall state. Instead,
investors should look at the market's response to price changes.
The combination of volume and price gives a better representation
of the dominant market sentiment.
The MFI is measured in values between 0 and 100, and then
is plotted as a line that oscillates between these two values.
A rise in the MFI indicates an increased buying pressure
while a drop in the index value itself is a sign of growing
selling pressure. As the name suggests, the Money Flow Index
represents the inflow and outflow of money into a particular
asset over a certain period of time. The instrument measures
buying and selling pressure by analyzing
price and volume data. When the MFI indicates buying pressure,
technical traders talk about positive money flow. On the other
hand, if the indicator signals selling pressure, the situation
is considered to have an inflow of negative money. The positive
and negative money flows are combined to create a money flow ratio.
The money ratio. It is used to calculate the value of the Money Flow Index.
The value of the MFI is then plotted on a line, which
is why it is considered an oscillator because it then fluctuates
back and forth. We can think of the Money Flow Index as something that is
used to help traders better identify the enthusiasm in the market,
or to provide an exact representation of the sentiment that dominates the particular asset class in any given moment.
Simply put, the MFI is used to find out how and how much of
a given instrument was traded.
It is convenient for traders, as it paints the buying and
selling pressure as a simple numerical value that is easy and
quick to comprehend and understand. But how can this positive- negative money flow thing help us while trading?
Well, the money flow's primary use is to help traders spot
upcoming changes in the price trend.
These can be reversals, divergences, failure swings, the list
goes on and on. By getting an exact representation of the price and
volume data about a particular security, traders can better plan their further moves.
For example, if the MFI signals an increasing selling pressure,
the trader can consider going short to protect his portfolio
from potentially losing value. On the other hand, a building up
of buying pressure can help us better time the market to capitalize on the uprising that is to come.
Let's take a moment to talk about the calculation process behind the MFI.
That way, we actually understand where the information is
coming from instead of just simply blindly following it. We'll
start off with the formula itself.
And this is the calculation, and if you're interested in copying this down,
I would just recommend pausing the video, taking a picture, or just writing it down yourself.
The Money Flow Index is going to be equal to 100
minus 100, over 1 plus the money flow ratio.
The money flow ratio is going to be equal to 14 days positive money flow,
over the 14 days negative money flow.
Then, we have the raw money flow, which is going to be equal
to the typical price, times the volume. Then finally, we
have the typical price, which is going to be the high plus low
plus close, all over 3. It might seem complicated at first,
but the good news is remember,
this is an indicator where it is doing this math for you,
so don't feel like you're going to have to do this
on a daily basis. To better understand how to calculate
the MFI, let's just go through the step by step process.
The first step would be to start by calculating the typical
price, which is down here at the bottom, for each of the last
14 periods. For each period, we would mark whether the price
has gone up or down. That way, we can tell whether the raw
money flow is positive or negative. Then, we would calculate
the raw money flow. After this, we would then add up all positive
money flows for the last 14 periods, and divide them by the
negative ones to calculate the money flow ratio. Then finally,
we would calculate the MFI using this formula.
Once we do this, we then use the last 14 periods as a
basis for our calculations going forward.
Once again, this is how it's done, this is how it's calculated, and
this is where it comes from, but in all reality, you'll probably
never actually have to do this math yourself.
Similar to all leading indicators, the MFI helps traders to
predict expected market movements a little bit better. To do that,
it focuses on identifying two main scenarios; overbought and
oversold scenarios. Overbought and oversold markets are identified
through the value of the MFI, as it is measured on that scale
that we talked about from 0 to 100. Depending on where the MFI stands,
the trader can get a sense of whether the particular market is overbought, oversold, or on the neutral zone.
That way, he or she can discover possible trading opportunities to capitalize on. Usually, when the MFI is trading above 80,
this indicates an overbought scenario, while a value below
20 signals in oversold scenario. With the overbought scenarios,
the general idea is that if the MFI is above 80, it's overbought
because it's not common for the MFI to go all the way up to 100. Even moves above 90 are relatively rare in
today's markets, however, if the MFI does go above the 90 mark,
then the signal is generally considered to be pretty strong.
When the MFI ranges in the zone between the 80 and 90 area,
preferably falling from 90 to 80 going in that direction,
traders consider an overbought market that is usually getting
ready for a correction. Overbought situations arise when the
momentum and the price increase at a relatively fast rate
and surpassed that 80 mark, and the market is just unable to keep up.
In other words, when the price reaches a high point just relatively quickly.
When analyzing signals from the MFI,
it is also essential to keep an eye on price action of the chart itself.
It's always helpful to make sure that we're coupling our reads
with the indicator with the actual movements of price. The
oversold scenario occurs when the MFI drops below 20.
Just like we talked about with the MFI rising above 80,
but not commonly rising to 100, that holds true with the MFI
not commonly reaching zero. When the Money Flow Index moves from
10 to 20 in that direction, traders usually consider this
an oversold market that is getting ready for a correction
and could be due for some buying thereafter. A situation where
the MFI climbs towards the 20 mark while the price of the
instrument continues to decrease, indicates an upcoming
price reversal usually. Once again, it is always helpful to
make sure that we're coupling price action with the reads
that were getting from the indicator. Taking a look at the chart,
we can see a couple scenarios where the market was both overbought
as well as oversold.
Here, we had a scenario where the market is overbought, which followed
with a price correction shortly thereafter. Down here, where
the market was quite low on the MFI, almost right around that
20 mark, we found that the market was a little oversold,
and as such, we found a nice bullish move thereafter.
These are just brief examples of when the MFi is overbought
or oversold, and also it helps prove why we should always
pay attention price action. On the right hand side of the screen,
when we saw the MFI above the 80 mark, indicating a potentially
overbought scenario, the price action didn't agree.
There's not a whole lot of bearish price action occurring during this phase. Instead,
we have grindy bullish activity, and as such, it probably
wouldn't be a good idea or logical to expect the market to be falling at this point.
So in this scenario, the MFI is just indicating a further continuance of the bullish trend.
Traders also use the Money Flow Index to identify divergences
to generate trade signals as well. The Money Flow Index going one direction while price itself
is going another direction, is essentially what we're talking
about when we use the word "divergence". Of course,
there's going to be a bullish divergence where the outcome is expected
to be bullish, and then there's going to be a bearish divergence
where the outcome is expected to be bearish. On the chart here,
we actually have an example of a bearish divergence.
This is done when price is actually rising, the literal price is rising,
the highs are getting higher, but the Money Flow Index
highs are actually getting lower, as you can see down here at the same time.
This is an indication that something has to give, and generally,
we expect the "something to give" to be price.
We usually expect price to begin following the direction of the Money Flow Index.
In this case, we would use price action to identify
a proper point to jump into the market and use the confirmation
of bearish momentum to come, to generate a sell signal because
of the divergence. If we were to imagine the scenario the
other way around, there is also the bullish divergence,
which quite literally is just the mirror opposite. Instead of the
MFI going down, we would have the MFI rising while price itself is falling.
If price is falling while the MFI is rising,
then we have a bullish divergence
because we are expecting price to be rising thereafter.
Similar to divergences, failure swings are another way that
traders use the MFI to generate trade signals. Failure swings
can also lead to a price reversal just like the divergence.
There are two types of failures swings, just like the divergence,
we have the bullish and bearish variation. The common denominator
between both is that they unfold in quite a similar way. With a bullish failure swing,
the money flow indicator is to drop below 20, as we have here in this box.
This indicates the market is oversold.
The MFI recovers and then bounces back to surpass the 20 mark.
The MFI then drops a bit, but remains above the 20 mark,
as we have going on within this box on that little blue line
bouncing back and forth. The MFI then breaks above the previous high,
which occurred right here where I drew my little plus sign.
This is an indication of a failure swing where we might
potentially be looking to go long, and had we gone long at this location,
we can see that we did get a nice bullish outcome thereafter.
The bearish MFI failure swing is just simply going to be the exact opposite.
The money flow indicator needs to surpass the 80 mark,
which indicates an overbought market. Then, the MFI needs
to fall back below the 80 mark, and then it needs to pull
back towards the 80 mark, but fail again, setting a new low
in relation to the first pivot point that it created,
and at the moment that the market is now falling back and breaking
the new low, this is usually an indication where we would want to look in
for a sell. Because of the popularity of the RSI, which is known as the
relative strength index, I thought it was important to compare the Money Flow Index
to the relative strength index to put a better relative understanding
of the Money Flow Index when it stacks up. Similar to the MFI,
the RSI is also used to chart chart strengths and weaknesses
in price movements. It is based on the closing price for the recent period and
generates overbought and oversold signals to help the traders
find its opportunities. So we can think the RSI as this gorilla over here on the left.
However, this is really where the similarities between
the both indicators end because the difference between the MFI
and the RSI, which will consider this guy here on the right,
is that the ladder doesn't consider volume data.
The RSI doesn't take into consideration that volume data,
which means both indicators
look at different things. Accumulated during this observed period,
the MFI looks at volume where the RSI is looking at price changes.
This is why many refer to the MFI as a volume weighted RSI,
which basically means the MFI is the more complete indicator,
although the RSI is the more popular one for no real logical reason,
aside from the fact that it is just simply more popular.
At the end of all of it,
both of these indicators can be used quite comfortably by
the trader because ultimately, the success is going to be
dictated by the trader using it.
The Money Flow Index is a very fun tool to use and despite
being similar to the RSI, it has a very unique feel about it.
If you enjoy using oscillators, I strongly encourage you
apply the Money Flow Index to a demo account, so you can
play around with it with no risk, and see how you enjoy it,
or see how it pairs with your personal trading strategy.
But until next time folks, thank you for joining me as always.
Please click the like and subscribe button down below
if you haven't, and I will catch you in the next one. Cheers folks!