Money Flow Index (MFI)and the BSE
You are going to love this lesson. MFI is based on Money Flow but the two are not the same. Money flow analysis is a volume weighted relative strength index. It is effective for most markets selection because it gives a view of a stock market's essential strength or weakness. Normally, MFI shows the same trends as the price pattern; indicating that, in an uptrend, money is flowing into the market, and when prices fall, money is flowing out of the market.
First Some History The Money Flow Index was developed by Laszlo Birinyi, Jr. as a real-time variation on the On-Balance Volume indicator. Instead of using each day as a reference point (as OBV does), MFI analyzes each trade. And instead of ignoring the price or the amount that the market is up or down, MFI weights each trade by price. |
Calculation
The Money Flow Index requires a series of calculations. First, the period's Typical Price is calculated.
Next, Money Flow (not the Money Flow Index) is calculated by multiplying the period's Typical Price by the volume.
If today's Typical
Price is greater than yesterday's Typical Price, it is considered Positive
Money Flow. If today's price is less, it is considered Negative Money
Flow.
Positive Money Flow is the sum of the Positive Money over the specified
number of periods. Negative Money Flow is the sum of the Negative Money
over the specified number of periods.
The Money Ratio is then calculated by dividing the Positive Money Flow by the Negative Money Flow.
Finally, the Money
Flow Index is calculated using the Money Ratio.
How to use the MFI indicator Positive and negative divergences between price and the MFI can be used as buy and sell signals respectively, for they often indicate the imminent reversal of a trend. If price is falling, but positive money flow tends to be greater than negative money flow, then there is more volume associated with daily price rises than with the price drops. |
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This suggests a weak downtrend that threatens to reverse as money flowing into the security is "stronger" than money flowing out of it.
Chart example:
The MFI line can now be compared with the price of any security on the BSE or other stock exchange like the New York Stock Exchange to look for divergence.
Below is a day trading chart. This chart shows how the MFI line can be used as confirmation of a trend change. The line on the price chart (Point A to Point B) shows price moving down with Point B lower than Point A while the corresponding line on the MFI (Point C to Point D) shows the indicator moving up with Point D higher than Point C.
MFI Uptrend (Going long)
One way to trade the MFI is to trade divergence between price and the MFI line. Below is a day trading chart with the MFI indicator set at 14 and the Bollinger Band indicator set at 20.
Trading rules for going long (buy):
- The MFI line (Point C to D) is rising while price is declining (Point A to B).
- Enter on the first touch of price at the middle Bollinger Band line (Point E).
- Your stop will be the first candle that closes below the lower Bollinger Band line.
- Your target will be the first candle that closes above the upper Bollinger Band line (Point F).
Summary
The Money Flow Index (MFI) indicator shows positive and negative divergences between itself and price and can be used as a buy signal as it often indicates the imminent reversal of a trend. If price is falling, but positive money flow tends to be greater than negative money flow, then there is more volume associated with daily price rises than with the price drops. This suggests a weak downtrend that threatens to reverse as money flowing into the security is "stronger" than money flowing out of it.
Thank you for joining us in this stock trading lesson.
The Indiadaytrading Team
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Information, charts or examples contained in this lesson are for illustration and educational purposes only. It should not be considered as advice or a recommendation to buy or sell any security or financial instrument.