The Money Flow Index (MFI) is a dynamic technical oscillator that utilizes both price and volume data to generate insightful overbought or oversold signals for an asset. This powerful tool can also pinpoint divergences, heralding a potential change in the trend. The MFI oscillates between 0 and 100, offering a comprehensive view of market conditions.
Unlike traditional oscillators such as the Relative Strength Index (RSI), the MFI accounts for volume data in addition to price, making it a more detailed volume-weighted RSI.
Key Insights
- The MFI is a technical indicator that highlights overbought or oversold signals using price and volume data.
- An MFI above 80 is labeled as overbought while one below 20 indicates an oversold condition; thresholds of 90 and 10 can also be used.
- A crucial aspect of the MFI is divergence—a scenario where the indicator trends in the opposite direction of the price, often signaling a forthcoming reversal.
The Money Flow Index Formula Simplified
The calculations for the Money Flow Index include a few key steps, encoded in the following formula:
1Money Flow Index = 100 - (100 / (1 + Money Flow Ratio))
2
3Where:
4 Money Flow Ratio = (14-Period Positive Money Flow) / (14-Period Negative Money Flow)
5 Raw Money Flow = Typical Price x Volume
6 Typical Price = (High + Low + Close) / 3
When the price moves up from one period to the next, the Raw Money Flow is positive and added to Positive Money Flow, and vice versa.
Step-by-Step Calculation of the Money Flow Index
- Compute the typical price for each of the last 14 periods.
- Determine if the typical price is higher or lower than the previous period.
- Calculate the raw money flow by multiplying the typical price with the volume, using appropriate signs (positive/negative).
- Sum up all the positive money flows for the last 14 periods and divide by the negative money flows to get the Money Flow Ratio.
- Use the Money Flow Ratio derived in step four to calculate the MFI.
- Update the calculations with new period data continuously, always using the last 14 periods.
What Can MFI Reveal?
The MFI is highly effective in identifying divergences—a condition where the oscillator’s movements contradict the price, indicating potential trend reversals.
For instance:
- A high MFI above 80 that starts descending while the price climbs could signal an impending price drop.
- An oversold MFI below 20 that begins rising while the price plunges hints at a potential upward reversal.
Traders also keep an eye on larger divergences using multiple waves both in price and MFI. For example, if a stock peaks and the MFI clocks a lower high than the price, it could foreshadow a decline.
MFI vs. RSI: The Key Differences
While MFI and RSI are similar, the prime distinction is that MFI incorporates volume, leading proponents to affirm it provides advanced warning signals, especially for trend reversals, making it seemingly more reliable than RSI.
Be Aware of MFI’s Limitations
Despite its strengths, MFI isn’t infallible and sometimes issues false signals where the anticipated price movement fails to materialize. Similarly, not all price reversals will have divergences, so relying solely on MFI isn’t advisable. Complementary analysis methods and risk control strategies are recommended.
Related Terms: Relative Strength Index, RSI, Oscillator, Volume Analysis, Divergence.
References
- Fidelity. “Money Flow Index (MFI)”.
