The Money Flow Index (MFI) is an oscillator that weighs between the money coming into the market to buy a particular asset and the money being withdrawn from the asset through sales at a given period of time. To do that, it evaluates both price and volume in order to determine the purchasing and selling pressures in a particular market.
MFI is often referred to as “volume-weighted RSI” since it incorporates volume and is mathematically equivalent to the relative strength index (RSI) in terms of formulation and function as a momentum meter.
How it works
Finding price changes that don’t match open volumes and a decline in market players’ activity before the price turns is one of MFI’s most important goals.
As well as helping traders identify when an asset has been overbought or when it has been oversold, the MFI can also point to price divergences, which may suggest a trend reversal.
MFI’s principal usage will be to identify overbought and oversold, represented by values above 80 and below 20, respectively. It is an oscillator because it swings between the two extremes on a scale of 0 to 100 market levels since it is an oscillator.
Traders also keep an eye on the pivot point, which is 50 percent of the way up the chart. A value above 50 indicates that the asset is experiencing purchasing pressure, while a reading below 50 indicates that the asset is experiencing selling pressure.
Calculating MFI
- Get the Typical Price
The formula for TP= (High +Low +Close) ÷3
- Calculate Money Flow
MF = TP X Traded Volume
When the current average price is higher than the previous average price, the money flow is positive, and vice versa. Investors who have positive money flow are increasing their positions in the underlying asset, whereas investors who have negative money flow are lowering their positions in the asset.
- Calculate the Money Ratio (MR)
MR = Positive Money Flow (PMF) ÷ Negative Money Flow (NMF)
- Calculate the MFI
MFI = 100 – (100 ÷ (1 + MR))
MFI compared to RSI
The biggest difference between the two tools is that the RSI does not take into account volume data. As a result, the MFI is also referred to as the volume-weighted RSI. To some, the MFI is deemed to be a better predictor than the RSI because it is considered a leading indicator. Many traders, however, would employ both to validate any price indications because there is no consensus on which is better in the end,
The default placements of the RSI and the MFI are the other significant distinction between the two indicators. In the RSI, an asset is deemed oversold when it hits 30 and below, and the overbought default level is 70. Defaults are set at 20 and 80 in the MFI.
Pointers to trading with MFI
Overbought/oversold market conditions
As previously stated, an MFI value of more than 80 indicates that the market is overbought. When the indicator reads oversold, it is a good time to initiate sell orders because of imminent price reversals to a downtrend. A reading below 20 indicates that the market is in an oversold state.
It is a good idea to look for opportunities to put buy orders in the market when prices are oversold, as this indicates that the trend is about to reverse and possibly rally upwards. Traders should evaluate the strength of the momentum by checking the scale reading. This is because markets often remain oversold or overbought for long periods if the trend is very strong.
In addition, whenever the underlying price establishes a new high or low that is not corroborated by the MFI, this divergence may indicate that the price is about to reverse.
Divergences
Divergences, whether they are positive or negative, are among the most dependable trading signals because they are based on historical data. The term “positive divergence” refers to a situation in which the price progressively registers lower lows, while the MFI or another indicator records a higher low.
In contrast, if the price pattern registers higher highs, with MFI recording lower highs, we have negative divergence. The third trade indication from the indicator confirms positive and negative divergences, as they denote a failed attempt for an upswing.
Using this momentum indicator, traders may see the difference between the Money Flow’s lows and highs. Finally, a combination of price action and the MFI can be more effective. With some prior trading experience and familiarity with other momentum oscillators, the indicator is easy to grasp.
Retracements
When assessing the price of an asset, it is usually wise to buy into the trend that is prevailing in the market. Traders can benefit from MFI in this respect. When there is an uptrend, a decrease in the reading to below 20, followed by a rise above this level, indicates that the retracement has ended and that prices are now poised to resume the bullish charge forward.
Even when prices are trending upwards in a downtrend, a rise above 80 and subsequent decline below this level indicates that the correction is finished and prices are set to resume their downward trajectory.
In summary
The MFI is a proven indicator that can be used for profitable gains. Despite this, traders should not regard it as an all-encompassing trading tool. Over time, it serves as a momentum indicator, giving investors insight into how much money investors are putting into an asset or withdrawing from it. A trend-following system would not benefit from using this indicator because it focuses on finding price reversals in a market.
