CMF (Chaikin Money Flow)

Introduction of CMF

The stock market’s massive influence within the investing landscape cannot be understated, and taking a quick look at those daily trading volumes will be more than enough to cement that. 

Now, while there’s a ton of benefits to be had here, no doubt about it, the initial steps are always the hardest considering the amount of jargon that one has to deal with to even get a basic grasp of how things work.

Sometimes it can be a headache even for the professionals; however, there are tools that can somewhat alleviate that experience. 

These come in the form of indicators that can discern the many circumstances associated with the landscape, like reversals, uptrends, downtrends, and many others. 

Popular examples include the SMA, EMA, WMA, OBV, and others. But what we’ll be looking at here today is the Chaikin Money Flow instead.

What is Chaikin Money Flow (CMF)?

Interestingly, the Chaikin Money Flow, or CMF, indicator’s inception can be traced as far back as the 1980s! If you were wondering about the person behind its development, that would be Marc Chaikin. 

He’s a popular stock analyst and is the CEO and founder of Chaikin Analytics, LLC. But why did he build this in the first place? 

Well, to monitor the distribution and accumulation of a stock across specified periods. Now what do distribution and accumulation stand for here? Let’s find out below.

The Purpose of CMF

In the financial world, distribution is basically the process where assets undergo large sale positions, whereas accumulation would be large buying positions. 

Or you could just understand distribution as selling pressure and accumulation as buying pressure. So, yeah, the CMF indicator was made to identify that. But other than that, it could also be used to spot potential reversals and confirm trends.

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How is CMF Calculated?

While most prominent trading platforms that support the indicator will automatically calculate it for you, it won’t hurt knowing the details behind that, especially if you’re more of a curious type of trader. So, if you are one, read on; if not, you can just skip ahead.

CMF Formula

So, there are just three small steps to calculating the values of the CMF, and these include finding out the money flow multiplier, the money flow volume, and finally, the CMF itself.

So the formula for the money flow multiplier is basically this: 

Money Flow Multiplier = ((Close value – Low value) – (High value – Close value)) / (High value – Low value)

Now the next step would be to calculate that money flow volume, and you can do this by simply multiplying the period’s volume with that multiplier we obtained in the first step. It’s usually calculated daily, but it can be done weekly or even hourly.

Money Flow Volume = Money Flow Multiplier x Volume for the Period

Now for the final step, you just have to divide that daily money flow by the volume total for a certain period. The default number tends to be 21 days, largely because it highlights the trading that occurred throughout the past month. The formula looks something like this: 

CMF = 21-day Average of the Daily Money Flow / 21-day Average of the Volume

Key Characteristics of CMF

One thing that you may need to know is that some platforms might express the CMF values as decimals by dividing them by 100, whereas others indicate those values as between zero and 100. 

So naturally, a 0.45 value on one platform would be 45 on another. As far as key characteristics go, you might want to factor these into your trading endeavors, i.e., the different ranges that each platform may offer and also the 21-day default period.

How to Use CMF in Trading

You must have some basic understanding of the CMF by now, but how can you channel all that into some actual trading? How can you put the theory into practice here? Let’s find that out here.

CMF and Trend Confirmation

One of the more obvious use cases involves trend confirmation. So, when you have a continuous purchasing period with those CMF values sustained over zero, it’s an uptrend basically.

But if you get a continuous selling period with those values below zero, then you have a downtrend, and chances are, prices may continue going downward here. 

Higher readings, whether they be negative or positive, indicate stronger trends. And if readings appear to be rising, then that could indicate gaining momentum.

CMF Divergences

Now this one is a bit more subtle. Divergence basically happens when price action displays a bit of a different picture when compared to the CMF indicator. Don’t worry, we’ll explain. 

So, bearish divergence happens when price reaches new highs, but CMF readings don’t go as high. This could be interpreted as implying the potential impending of a down or bearish trend.

Bullish divergence is just the opposite of this, where prices fall to new lows but the CMF doesn’t follow suit with lower readings. So, an upside could be on the way if you see this happen.

CMF and Support/Resistance Breakouts

Another rather useful aspect of the CMF indicator is how you can use it to confirm breakouts! You could either wait for CMF to verify the price action’s breakout direction through trend lines or via resistance and support lines.

For instance, should the price break upwards or downwards through resistance or support, you may want to wait for the CMF to display a negative or positive value to validate that breakout direction. 

And there you go. This is how you can confirm bullish or bearish breakouts with the CMF indicator.

CMF Strategies for Different Trading Styles

Let’s take a look at how the CMF indicator fits in with some of the popular trading styles that you get to see within this landscape. We’re of course talking about day, swing, and long-term trading here.

Day Trading with CMF

If you’re good at day trading, then you can make use of some short-term trends, which you can obviously verify from the CMF indicator. 

Other strategies you may want to incorporate could involve intraday divergences, as those might lend you some good gains provided you know what you’re doing.

Swing Trading with CMF

But what about swing trading now? Well, like the day traders, you could use it to confirm trends, and because of the extra time you get to work with, you could always identify reversals with it. 

After all, swing traders typically focus on medium-to-long-term gains, and the CMF indicator can be a decent way to capitalize on reversals.

Long-Term Investing with CMF

As for those whose preferences lie within the long term, the CMF can likewise be adjusted according to their needs. Like they may set it in such a way that they may benefit from long-term trends and are easily able to identify distribution, aka selling pressure.

Advantages and Limitations of CMF

Can you imagine any indicator out there with zero limitations? No right? Knowing the limitations of anything can really help you make the most out of whatever it is you’re using by searching for workarounds or ways to reduce the risks. This is why we’ll be looking at the pros and cons here.

Benefits of Using CMF

As far as the benefits go, there is obviously how it’s able to blend volume and price in a manner that achieves significance. 

And significance in what? Identifying accumulation and distribution while confirming breakouts. Any trader who knows what he or she’s doing would be able to make the most of these benefits, and that’s the mark of a good tool in that it allows one to accomplish what they want without standing too much in their way.

Limitations of CMF

But what’s an indicator without its own set of drawbacks or shortcomings? Well, it’s a lagging indicator, so you can’t expect it to provide the most “timely” signals now. 

And speaking of signals, the potential for false signals is there too, especially within low-volume markets, so be on the lookout for that. And lastly, it doesn’t provide direct or exact buy or sell signals like some of the other indicators out there.

Conclusion

The Chaikin Money Flow, or CMF, can be a versatile indicator that blends volume and price data to track money flow out of and into assets over certain periods. 

By offering insights regarding how strong trends can be or whether there’s potential for reversals, traders can make more informed decisions pertaining to their positions. 

But while that’s all well and good, knowing the limitations of it is important too, like we already discussed. At least that way, you can minimize your risks and ultimately become a more successful trader with a thorough understanding of stock market dynamics as well as being adaptive to altering conditions.