MFI (Money Flow Index)

Introduction

The world of stock trading can leave even the most experienced of traders in awe with its volatility and every manner of trends and whatnot. It’s precisely circumstances like that that make the stock such a lucrative space for trading enthusiasts.

Because of that you have a steady stream of newcomers to the landscape, adding to those massive daily trading volumes even more.

However as good as that can be you can’t expect there to be no catches whatsoever. For one getting into it isn’t easy and even when you have familiarized yourself with it accurately identifying the state of the market is no easy task.

All that is why you have so many different types of indicators that are meant to gauge various sentiments or circumstances.

For example you have those moving averages, the RSI, and various others. But it’s the Money Flow Index or the MFI that we’ll be directing ourselves toward.

What is MFI (Money Flow Index)?

The Money Flow Index or MFI is essentially a technical oscillator that’s comparable to the RSI short for Relative Strength Index. Avrum Soudack and Gene Quong made it way back in the 1990s! and it’s also sometimes referred to as the volume-weighted RSI.

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The Purpose of MFI

But what of its purpose? Well like the RSI it can identify overbought and oversold conditions within the market and even divergences which basically warn of an impending change of price trends. 

Unsurprisingly its values move anywhere from zero to 100. Still there’s one major difference between the RSI and this indicator that you have to know about and that’s how it uses both volume and price in its calculation. So its other name makes a lot more sense now that you know about this.

How is MFI Calculated?

Practically every single time the trading platform that you use will calculate the MFI for you which is why you don’t really need to learn how to do it yourself. But if you cant help being curious about it then we’ll discuss the steps needed below.

MFI Calculation Steps

There are about six steps that you will need to carry out if you want to finish calculating the MFI. For first step you will have to determine the periods you want and then calculate the typical price for each of those. 

Then for every one of that period see make a note of it when the typical price is lower or higher than the previous period which will show you whether or not the raw money flow is negative or positive.

Following that you can just calculate that raw money where you multiply the typical price with the volume for that specific period. Use either positive or negative numbers based on whether that period was down or up. 

The next calculation for you would then be the money flow ratio and you get that by just totaling up every positive money flow across the number of periods that you’ve set and divide it with the negative money flows over those same periods.

Finally calculate that MFI now using that ratio we talked about and continue with your calculations as every new period ends and use only what you’ve set as the number of periods to be.

The formula for the MFI is as follows.

Money Flow Index = 100/1 + Money Flow Ratio

Key Characteristics of MFI

So the key characteristics based on what has been discussed so far has to be the typical price which you can get by adding the high, low and close prices and then dividing them by three, the money flow ratio and the raw money flow.

How to Use MFI in Trading

By now you must have a fair idea of what the MFI is supposed to tell you but knowing it and actually trading with it are two different things which is why we’ll be looking at how you can do that with the indicator here.

Identifying Overbought and Oversold Conditions

If there’s one thing the indicator is good for then it’s for spotting overbought and oversold conditions which can then be used to signal potential trading opportunities.

But you should know that moves lower 10 and over 90 tend to be rare. So traders just look for that move back over 10 to signal long trades and that drop below 90 to signal short trades.

MFI Divergences

One of the main ways you can go about using this indicator is to spot divergences as that’s what it’s most popular for. If you weren’t aware a divergence occurs when the oscillator moves in the opposite way the price is going. And if this happens then it’s often treated as a signal that a potential reversal within the prevailing price trend is set to occur.

For instance if you have an extremely high Money Flow Index that starts to fall below readings of 80 with the security continuing to climb in price then this could be treated as a reversal signal or divergence to the downside. 

On the other hand if you see very low MFI readings that climb over readings of 20 but the price of that stock is continuing to sell off lower then this could only mean a possible divergence towards the upside.

A lot of traders even like to look for greater divergences using several waves within the MFI and price. For instance if you see a stock peaking at $11 pulling back to $9 and then finally rallying to $13 then that means that the price has reached two successive highs with $11 and $13.

But if the MFI produces a lower higher once the price reaches $13 then that means the indicator isn’t confirming that new high. This could just be another foreshadowing of price decline later on.

MFI and Trend Confirmation

From what can be garnered earlier it’s clear that the indicator can be used as a way to confirm trends and that comes with its own set of benefits. The first and definitely not the last would be to prevent you from living under a rock when it comes to your favorite stocks or other assets.

MFI Strategies for Different Trading Styles

But what about those trading styles that you see a lot of traders using and how can the MFI cater to that? Let’s find that out then below.

Day Trading with MFI

If you’re a day trader then you know it’s those short term gains that have grabbed your attention and you have no interest for the long term.

In that case you could just adjust employ a shorter lookback period or time frame in your calculations and then employ strategies that involve scalping or trend confirmation.

Swing Trading with MFI

As for swing trading since your focus is mainly directed toward medium to long term gains you’re opening yourself up for more opportunities too because of the increased timeframe with which you work with.

So you could just modify those time frames by a bit to factor in all that and use strategies that incorporate trend reversals or overbought and oversold conditions.

Long-Term Investing with MFI

But what about the long term traders? Well since it’s the long term you’re looking at then you may want to increase your time frames to reflect that and use strategies that make the best use out of that.

A few examples of that would divergences or reversals.

Advantages and Limitations of MFI

If you want to make the most out of your trading then that means knowing both the benefits and limitations that come with it .

Benefits of Using MFI

Now with those benefits, the fact that it includes volume means that you get a more holistic understanding of the market.

Then there’s how it can identify overbought and oversold conditions, detect divergences and is versatile and adaptable in that it can support various trading styles.

Limitations of MFI

As for the limitations, the potential for false signals is still there unfortunately and a popular example of that would be a divergence not resulting in price reversals.

Other than that the indicator could even fail to warn you of something vital and because of that you cant really use it as a standalone tool a lot of the time.

Conclusion

The MFI can be one of the most valuable tools that a trader can have at their disposal especially if they want to incorporate volume within their analysis.

Although it has quite a few benefits that you can use in your favor you should not gloss over those limitations and learn to trade around them if you are to be successful in your goals.