What is the Money Flow Index - MFI
The Money Flow Index (MFI) is a technical oscillator used for identifying overbought or oversold conditions for an individual security or an ETF or index.
Unlike conventional oscillators such as the relative strength index - RSI, the money flow index incorporates both price and volume data, as opposed to just price. For this reason, some analysts know it as volume-weighted RSI. However, it is as easy to read as other oscillators, with extremes at readings of 0 and 100.
BREAKING DOWN Money Flow Index - MFI
The Money Flow Index, like most oscillators, provides the most powerful and predictive trading signals when there is a divergence, meaning the oscillator is moving in the opposite direction of the underlying security, index or ETF price. As is the case with RSI, this is a signal of a potential reversal in the prevailing trend.
For example, a very high Money Flow Index that begins to fall below a reading of 80 while the underlying security continues to climb is a reversal signal to the downside. Conversely, a very low MFI reading that climbs above a reading of 20 while the underlying security continues to sell off is a reversal signal to the upside.
The developers of the MFI, technical analysts Gene Quong and Avrum Soudack, typically use a 14-day period for calculations, as does the default for many technical analysis software packages.
Calculating the MFI involves calculations that can be entered into a spreadsheet, but most often are preloaded into analysis software. The software first calculates the average of the high, low and closing prices during the 14-day lookback period. This is known as the so-called typical price. Next, the high low and close prices for each day are summed and divided by three. This end result is then multiplied by the day’s trading volume.
The typical price is then analyzed over time. Money flow is positive when the typical price is rising on successive trading days. It’s negative when the typical price is falling on successive days. A running tally of the negative or positive money flow is then kept. The so-called money ratio is the result of dividing the positive money flow by the negative money flow for the totality of the 14-day lookback.
The Money Flow Index is calculated by taking 100 - 100/(1 + the money flow ratio.)
Money Flow Index vs. Other Oscillators
There are seeming advantages to incorporating volume into the oscillators, just as technical analysts give more credence to price levels accompanied by significant trading volume. For this reason, MFI can sometimes provide earlier signals versus RSI or other oscillators. Conversely, it sometimes will not provide a false signal provided by other oscillators.
While some traders prefer using the Money Flow Index alone, many prefer to use it in conjunction with other trading indicators, sometimes even with other oscillators for confirmation.