You’re probably here to learn about what Money Flow Index (MFI) can do as a technical indicator in trading.
This guide covers the key components of the MFI and how it provides insight on chart patterns to traders.
Contents
You can see two examples in action as we interpret the MFI for Google stocks and explore the MFI divergence for Microsoft stocks.
What Is The Money Flow Index?
The Money Flow Index (MFI) uses price and volume and the concept of accumulation distribution.
It creates an overbought and oversold indicator that is helpful in confirming trends in prices and warning of potential price reversals.
The inputs to the Money Flow indicator are given below:
- Typical Price: (High + Low + Close) / 3
- Money Flow: Typical Price x Volume
- Positive Money Flow: The Money Flow on days where the Typical Price is greater than the previous day’s Typical Price.
- Negative Money Flow: The Money Flow on days where the Typical Price is less than the previous day’s Typical Price.
- Money Ratio: Positive Money Flow / Negative Money Flow
- Money Flow Index: 100 – [100 / (1 + Money Ratio)]
The chart below of Google (GOOG) stock shows the Money Flow Index in action:
How To Interpret The Money Flow Index
Here are the two main thresholds to interpret the MFI:
- Below 20 is considered oversold; a trader might look for buying opportunities at these levels.
- Above 80 is in overbought territory; a trader might look for sell signals here.
In the chart above of GOOG, the downtrend in price was confirmed by the downtrend in the Money Flow Index.
Once the MFI entered the oversold area, traders might be advised to begin to reduce their short sell positions and buy to cover.
A Tool For Confirmation And Warning
Later, the price of Google increased, and the MFI indicator confirmed that increase.
This is a signal that suggests that the trend in Google still might have buying pressure and that the stock trader might want to continue holding their long position in the stock.
In addition to acting as a confirmation tool, the Money Flow Index might be used to warn of potential price reversals. Money Flow Index divergences is next.
How To Spot MFI Divergences
Since the Money Flow Index uses volume in its calculation, this indicator can prove effective as a divergence indicator.
The theory is as follows:
- If price is rising, and the volume on up days is greater than the volume on down days, then this is confirming of the price rise.
- Likewise, if price is falling and the volume on down days is greater than the volume on up days, then the recent downward trend in stock prices is confirmed.
- In contrast, if prices rise, yet the volume on the up days is less than the volume transacted on down days, then money is secretly pouring out of the stock; this is a bearish divergence.
- And similarly, when prices fall, but the volume on the down days is less than the volume on up days, then money is flowing back into the stock, a bullish divergence.
An Example: Using MFI Divergence On The Microsoft Stock
The chart below of Microsoft (MSFT) shows the effectiveness of the Money Flow Index in detecting bullish and bearish divergences:
In the chart above, beginning on the left, Microsoft’s stock price is in a downtrend; however, the Money Flow Index is not going downwards, in fact, it is sloping upwards. This is a good illustration of a bullish divergence.
On the second half of the chart, Microsoft is making new highs, yet the Money Flow Index is making lower highs, a bearish divergence.
What Does The Outflowing Money Mean?
Stock traders of MSFT might be advised to scale out of their position because money is flowing out of Microsoft stock.
Later, the price of Google increased, and the MFI indicator confirmed that increase.
This might be interpreted that the trend in Google still has buying pressure and that the stock trader might consider continuing to hold their long position in the stock.
The Money Flow Index is an interesting technical analysis tool due to its ability to incorporate both price and volume into its calculations.
Other technical analysis tools similar to the Money Flow Index, is the On Balance Volume indicator and the Chaikin Oscillator.
Where To Trade Using MFI Analysis?
If you are interested in trading stocks & commodities using technical analysis, have a look at our reviews of these regulated brokers available in to learn which charting & analysis tools they offer:
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 74%-89% of retail investor accounts lose money when trading CFDs. You should consider whether you can afford to take the high risk of losing your money.
Further Reading
Learn more about technical analysis indicators, concepts, and strategies including Momentum, Gann’s Theory, Moving Averages, and many others.
Also see our guides on Forex, Bitcoin, CFD, Stocks, Cryptos, Bullion trading, and Options brokers to find out which tools brokerages offer their clients.
FAQs
What is the difference between MFI and RSI?
The MFI analysis tool focuses on tracking how much money flows in and out of a particular asset, while the RSI focuses more on average price movements and ranges. Both the MFI and RSI are momentum oscillators and can be used together to better analyze chart data, to build a trading strategy, and confirm signals.
What is the Smart Money Flow Index?
The smart money index, also known as SMI, is an investors’ sentiment analysis tool. The formula for SMI is Today’s SMI reading = yesterday’s SMI – opening gain or loss + last hour change. So, the SMI measures the difference in the previous day’s SMI reading, minus the present day’s opening difference from yesterday’s price — a gain or loss.
