Trading With The Money Flow Index (MFI)

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The Cash Flow Index (MFI) is a modified RSI indicator with an additional volume component. Simply put: think of MFI as an RSI that calculates volume divergences.

The Cash Flow Index (MFI) is a general indicator used by investors and day traders. It is one example of classification of indicators in technical analysis that measures volume flows.

The MFI was initially developed by two analysts, Avrum Soudack and Gene Quong. Avrum and Quong took Welles Wilder’s popular oscillator, the Relative Strength Index (RSI), and applied a volume calculator to Wilder’s original indicator.

The MFI is one of many other indicators created where additional data is applied to Wilder’s original RSI formula.

Another example of an “update” of the RSI would be Constance Brown’s Composite Index, which measures momentum with the RSI. An easy way to think of the MFI is as a volume RSI.

Note that just like the RSI, the MFI is considered a jumped oscillator, which means it only measures and prints values ​​between 100 and 0.

MoneyFlowIndicator

Cash Flow Index (MFI) Formula

The MFI measures movements in and out of instruments by labeling them “up” days and “down” days.

When you look at where the MFI line is on a chart, you look at the average price of the time period multiplied by the time period volume. The first part of the formula identifies the cash value:

MF = {(High + Low + Close) / 3} * Volume

After the cash flow value, the Cash Flow Ratio (MFR) is calculated.

If the MF is larger than the previous period, this is known as Positive Cash Flow (PMF), with the inverse as Negative Cash Flow (MFN). The default period for the MFI is 14.

To determine the Cash Flow Ratio, the sum of the total PMFs in the 14-period interval is divided by the sum of the total MFNs in the same range.

MFR = sum of PMFs / sum of NMFs

Once MF and MFR have been established, the final calculation takes place to give the MFI value:

MFI = 100 – (100 / (1 + MFR))

How the MFI is Used

Fortunately all of the above calculations happen automatically.

While the calculations behind how the MFI is plotted seem apparent, fortunately, the way traders apply it in their analysis is simpler.

Since the MFI is derived from Wilder’s RSI, it is not surprising that the MFI uses many of the same data to identify trading opportunities. This is primarily done by identifying divergences.

Divergences are structural differences between an instrument’s price chart and an equivalent oscillator. In the RSI, Wilder’s primary divergences announced attention to were:

  • Regular bullish divergence
  • Regular bearish divergence
  • Hidden Altitude Divergence
  • Hidden Bear Divergence

These same kinds of divergence are found in the MFI. However, note the difference between the regular and hidden divergences.

Regular bullish and bearish divergence gives traders a warning that the current trend may soon end and become a corrective or broader reversal. Regular divergence is a countertrend analysis.

Hidden bullish and bearish divergence gives traders a warning that a likely move is returning to the previous trend. Hidden divergences almost always appear at the end of a correct displacement. You will see them often in bullish and bearish continuation patterns like flags and pennants.

Regular bullish divergence

Money Flow

Regular bullish divergence occurs when a price chart shows lower lows, but the oscillator in the identical period prints higher lows.

This is a warning sign that the current lower move may turn and instead move higher. Positive expectation rates for reversal or correction are higher if the MFI is around the value level of level 20.

Regular bearish divergence

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Regular bearish divergence occurs when a price chart makes higher highs, but the oscillator in the same period prints lower.

This is a warning sign that the current move higher may turn around and start a new corrective move or trend reversal. Ideally, the MFI would be close to the 80-value area for a trend change or corrective move.

Hidden Altitude Divergence

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Hidden does not mean hidden or that it is hard to find; hidden means we exchange the measure.

In a regular bullish divergence, we measure lower low prices versus higher lows in the MFI. For hidden bearish divergence, we want to look for higher lows in the price chart and lower lows in the MFI.

Hidden bullish divergences are valid only if the previous general trend was bullish – they should be ignored if the instrument is already on an urban market.

Hidden Bear Divergence

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For hidden bearish divergence, analysts are looking for low highs in the price chart and higher highs in the MFI.

The hidden bearish divergence that appears in a high trend should be ignored and not valid – it only works if the previous trend was bearish.

Extremes in the MFI

As with traditional RSI, the MFI is often used to spot over-bought and over-sold market conditions. Values ​​above 80 are said to be too bought, while values ​​below 20 are considered too sold.

If only it were that easy. The MFI is simply a calculation of price and volume that could help you spot possible short-term highs and bottoms.

Just as you can’t wire the electricity in a house because you’ve found an electrician’s gear, don’t assume you can shorten extreme readings in the IFM without a compelling reason to do so.

This is not intended against MFI, but only to emphasize that sometimes new traders may be caught by a binary reading of a technical oscillator that does not have much meaning without context.

Consider this.

Think of relentless momentum while running.

Tesla in 2020 for example. Many times during its rally, it was oversold by the MFI indicator. Would you shorten the stock just because of the indicator reading? We all know how many savvy traders and investors have brought in the cleaners trying to step up to that momentum.

When a regular divergence appears near the extremities, do not assume that a reversal is immediate or probable. Instead, regular divergences can also become trending ongoing arrangements. This can happen when the MFI trades at 80, slightly slower then quickly returns to 80.

Smarter free traders using an indicator like MFI will usually have a specific reason they want to trade, and then use the MFI as an input signal.

Perhaps they identify a low candelabra that indicates a possible near-term peak. Or maybe a trend loses fervor and fails to make new highs.

Bottom Line

The Cash Flow Index is a modified RSI. Tons of traders have been successfully and unsuccessfully using the RSI indicator for decades.

They say “if it doesn’t break, don’t fix it,” but let’s consider that the RSI was developed by Welles Wilder in the 1970s, when computing power was limited. So if adding a volume component to an RSI improves it than we use it.

But the question is, does it really work better than the RSI? That really depends on what you’re trying to do.

Maybe you’re testing a very basic average reversal system where you fade extreme readings on the indicator. Or maybe you’re using complete discretion.

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