What is the Money Flow Index?

02 April 2021

    In this article we will present you the Money Flow Index (MFI) indicator. The MFI is a technical analysis indicator that is used to measure the current market momentum. It is an oscillator with oscillating values between 0 and 100, similar to RSI, but different in that it does not only consider price information, but volume as well. It is used to highlight overbought or oversold conditions for the relevant instrument and generate relevant buy and sell trading signals. A typical reading of the MFI is as follows: values above 80 indicate an overbought area and values below 20, an oversold one. This is the most common setup for MFI, but some traders prefer a more conservative 90/10 setup.

     

    Money Flow Indicator Calculation

     

    Below we present the formulas used to calculate the MFI indicator values.

     

    Money Flow Index = 100 - (100 / (1 + Money Flow Ratio))

     

    Where

     

    Money Flow Ratio = X Period Positive Money Flow / X Period Negative Money Flow

    Money Flow = Typical Price * Volume

    Typical Price = (High + Low +Close) / 3

     

    The Money Flow is considered positive when the price increases from one period to the next, and it is considered negative when the price decreases from one period to the next.

     

    The final outcome of the MFI calculation is a value between 0 to 100, which is usually plotted on a chart below the main price chart. We can see an example of a plotted Money Flow Index indicator from Fondex cTrader below.

     

    Money Flow Index

     

    Money Flow Index in Fondex cTrader

     

    Although technically an oscillator, the Money Flow Index is classified as a Volume indicator due to the fact that volume information is used for its calculation. To add an MFI indicator in Fondex cTrader, right-click on the chart and navigate to Indicators > Volume > Money Flow Index. After clicking on Money Flow Index, the below form will appear. 

     

    Money Flow Index

     

    In this form you select the Money Flow Index Periods and Shift, customize your line’s color thickness and type, set the overbought and oversold levels, and press OK. The MFI indicator will be added to the bottom of your screen.

     

    What Does the Money Flow Index Indicator Tell You?

     

    Similarly to other oscillators, the Money Flow Index is an indicator that displays the current market momentum and indicates if a market is in an overbought or in an oversold state. The typical values of an overbought market is > 80 and for an oversold market < 20. Traders monitor the Money Flow Index indicator to identify if the market is in a trending state, and if a reversal or a price correction is probable. Based on the value of the Money Flow Index, combined with other observations about the market state, successful trading strategies can be devised. We briefly present one of them below -  the Money Flow Index Divergence strategy.

     

    Money Flow Index Divergence Strategy

     

    One of the most popular ways of using the Money Flow Index indicator in your trading strategy is the Money Flow Index Divergence strategy. This strategy identifies entry points by detecting Money Flow Index and price divergences. A divergence is a scenario where the indicator is moving in the opposite direction of the price. A Money Flow Index indicator divergence happens when the two following events occur a) the price moves upwards, following a buying trend and forming higher highs, but the Money Flow Index indicator forms lower highs c) the price moves downwards, following a selling trend and forming lower lows, but the Money Flow Index indicator moves upwards, forming higher lows. A Money Flow Index divergence gives insight that the current price trend is fading out, making a reversal possible.

     

    The chart below shows a typical Money Flow Index divergence.

     

    Money Flow Index

     

    We can see that the price, while in a bullish trend, forms new higher highs (red line and yellow rectangle inside the price chart). However, the Money Flow Index indicator is forming Lower highs (red line and yellow rectangle inside the indicator chart), diverging from the price trend. At this point it is evident that the bears are gaining ground again, and that a trend reversal might be in the making. Indeed, the subsequent price action confirms this signal and the price starts trending downwards. Therefore this divergence is a valid sell signal.

     

    You can use Money Flow Index divergence to spot reversal points, but your signal would also benefit by combining a Money Flow Index divergence with some more confirming information, such as a reversal price pattern (i.e: engulfings or trend line break outs).

     

    Limitations of the Money Flow Index Indicator

     

    The Money Flow Index Indicator, as any other technical indicator, always needs to be used in context. An out of context interpretation of Money Flow Index Indicator patterns can generate a lot of false signals that could lead to substantial losses. Therefore, when using the Money Flow Indicator, always consider the market fundamentals that currently move the market, and combine the signals with other confirmation signals, like trend indicators, support/resistance levels and the relevant price action taking place on the chart.

     


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