Why You Need the Money Flow Index
Smart tools such as the Money Flow Index can help you make more informed trading decisions by digging deeper than common consensus.
Successful online stock trading involves constant trading education. And technical analysis plays a major part in it. This analysis is made up by oscillators. The MFI (Money Flow Index) is the more efficient of these.
Where the Money Flow Index Comes In
If you need to identify whether a security, index or ETF is in oversold or overbought conditions, the MFI (Money Flow Index) can help. The MFI includes price and volume data rather than just the price data incorporated by the more conventional RSI (relative strength index). Despite being more comprehensive than the conventional oscillators, it is still easy to read. The extremes are at 0 and 100 readings.
It’s when a divergence occurs that you get the most predictive and powerful trading signals. A divergence is when the oscillator moves in the direction opposite to the underlying price of the security, ETF or index. This indicates a potential reversal in trend.
Stating With Example
If a really high Money Flow Index, for example, starts falling below an 80 reading as the underlying security keeps climbing, it indicates a reversal signal towards the downside. On the other hand, an MFI reading that is very low and climbs over a 20 reading as the underlying security keeps selling off indicates a reversal signal towards the upside.
MFI has been developed by Gene Quong along with Avrum Soudack, both technical analysts. They make use of a 14-day period for the calculations. And that’s the default setting for many of the software packages relying on technical analysis.
Calculations by the Analysis Software
You can get calculations for the MFI preloaded into the analysis software, though you can also enter it into a spreadsheet. The software initially calculates the high, low and closing price average in the lookback period of 14 days. This is the typical price. After that, the high low as well as close prices for each of the days get added and divided by three. You then have the end result multiplied by the trading volume of the day.
You have the typical price analyzed over time. When the typical price rises on consecutive trading days, you have positive money flow. One the other hand, if the typical price keeps falling successively on consecutive days, the money flow is negative. A tally chronicling the positive or negative money flow is maintained. This money ratio depicts the result of the positive money flow being divided by the negative money flow for the 14-day lookback.
Including Volume Provides MFI with Significant Advantage
Including volume in the oscillators is advantageous. The MFI can therefore sometimes provide signals earlier than the RSI and the other oscillators. It will also not give false signals as the other oscillators do. That gives sufficient reason for traders to use just the Money Flow Index, but there are many traders who use it with the other oscillators, just for confirming their findings based on the signals given.
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