The Cheat Sheet to Using the Money Flow Index as a Technical Analysis Tool

The Money Flow Index indicator is said to be one of the most effective indicators in determining the reliability of overbought and oversold conditions, as well as the current action in foreign exchange markets. According to both the indicator’s developers and momentum traders, granted you use it accordingly, predicting positive monetary values can be accomplished in a matter of weeks. So, how well can you analyze charts with it?

The Money Flow Index Indicator Basics

The Money Flow Index or MFI indicator is a momentum indicator developed by Avrum Soudack and Gene Quong. Behind it, the idea is to identify buying (i.e. when current prices are rising) and selling (i.e. when current prices are declining) conditions in the market. By using a stock’s price together with its volume, you can start measuring actions, which ultimately allows you to predict whether certain trends are worth following. Since among its elements is Relative Strength, it is sometimes referred to as volume-weighted Relative Strength Index.

Let’s Calculate, Shall We?

As per the MFI indicator developers, a period of 14 days is suggested for making calculations. Since this technique of analyzing price actions and price positions is ideal when market conditions are rather stable, using the indicator shouldn’t be rushed.

The steps:

  1. Calculate the average price by adding peak prices and closing prices, then, dividing them by 3.
    1. Average price = (maximum price + minimum price + closing price) / 3
  2. Identify the raw money flow by multiplying the average price by its volume.
    1. Raw money flow = average price X volume
  3. Determine the money flow ratio by dividing the positive flow by the negative flow.
    1. Money flow ratio = (14-day positive money flow) / (14-day negative money flow)
  4. Identify the MFI.
    1. MFI = 100 – [100 / (money flow ratio + 1)]

Is MFI Similar to the Chaikin Money Flow Oscillator?

The MFI indicator and Marc Chaikin’s the Chaikin Money Flow Oscillator are quite similar. Both of these tools are commonly used by traders, especially momentum traders, to determine price action, as well as current market conditions. However, their strategy of identifying money flow is quite different.

With the Chaikin Money Flow Oscillator, as opposed to using the MFI indicator, you don’t analyze market conditions by relying on a single average to determine price action. Instead, to arrive at a result, two exponential moving averages have to be weighed.

Wait: There’s something to Remember

In using the MFI indicator, it’s recommended to acknowledge information presented to you by other indicators. Since determining the money flow ratio, which is integral for identifying the MFI, is accomplished midpoint, failure to pay attention to any influential factor along the way can make the result questionable. For instance, any data that supports a chosen entry point and exit point for your stocks is valuable.

In Conclusion

The MFI indicator is very useful. A drawback is that on its own, it couldn’t allow you to make accurate analysis. Provided you’re open to the idea of turning to plenty of tools, however, this isn’t usually a problem. Alongside other indicators, you can predict price action, price positions, and overall, the current conditions in the foreign exchange market.
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