Investing With The Money Flow Indicator
Money Flow Indicator is considered an oscillator. The Money Flow Index was created by Gene Quong and Avrum Soudack and is also known as a volume-weighted Relative Strength Index (RSI). The difference between the two is that the Money Flow Index also allows for volume, where as the Relative Strength Index will only incorporate price. With this in mind, when the Money Flow Index happens to move away from price in the opposite direction, a trader will often consider the divergence occurring as a key indicator that a current trend is in the process of changing. When the money flow shows positive, it is due to the price rising from buying pressure and conversely when the money flow is negative, it is because the price is declining from selling pressure. From here, a trader will enter the ratio of positive and negative money flow into a formula for Relative Strength Index, which will in turn create an oscillator with a range of 0 to 100. If the Money Flow Index is over 80, then it can be a signal of a market top. If the MFI is below 20 then it can be a sign of a potential market bottom. As the Money Flow Index is connected with volume, identifying price extremes and reversals is what it is best suited for.
Important Aspects When Using The Money Flow Indicator
Some important things to note from the above calculations is that the Raw money flow is ultimately a dollar volume. This is due to the formula including typical price multiplied by volume. If the typical price advances from period to period, then the Raw Money Flow is positive, however, if the typical price decreases, then it is negative. As shown in stage 5 of the calculations, the positive and negative money flows are used to form the basis for the Money Flow Index (MFI). From here, a volume-weighted indicator is created when the Relative Strength Index formula is correctly applied.
When To Use The Money Flow Indicator
In summation, the Money Flow Index can used as an indicator to predict trend reversals but is more commonly used to determine the strength of money coming in and going out of a stock. The Money Flow Index range is between zero to one hundred and is used in a similar way to the Relative Strength Index. The difference between the Money Flow Index and Relative Strength Index is the Money Flow Index takes into account volume where as the RSI is purely price driven.
In the chart below you will see the money flow indicator being used in a real world scenario.