The Money Flow Index (MFI), i.e. the cash flow index, is not so popular indicator of a technical analysis as MACD, RSI, or moving averages, but is used by quite a large number of investors. It can be used on all types of markets – stock, forex, debt or commodity. Moreover, MFI can equally be used in both short-term and long-term trade. We should not forget that not all good technical analysis indicators are immediately gaining in popularity, so it’s worth to take interest in it for a moment and check its usefulness in our own investment strategy.
The Money Flow Index is an oscillator measuring the amount of cash flow incoming and outgoing from a given market. The MFI is somewhat similar in its structure to the Relative Strength Index. The difference is that apart from the price change, it also takes turnover into consideration. MFI is one of four basic volume indicators, alongside On Balance Volume, Volumes and Accumulation/Distribution tools.
Construction and Operation of Money Flow Index
MFI is presented as a separate oscillating chart between the levels from 0 to 100 points. Two significant levels of the indicator are 20 and 80 – we’ll discuss them, however, a bit later. The principle behind the Money Flow Index is relatively simple – a drop in volume, i.e. a decrease in turnover during an uptrend, is a prelude to the end of an uptrend, and a drop in volume during a downtrend means supply side depletion. Investors and speculators typically use the Money Flow Index in conjunction with other technical analysis tools, but there are also people who use only MFI – but these are sporadic cases. MFI can be used for different intervals, but like the Relative Strength Index, which we wrote about in a separate article, is most often calculated for the last 14 periods.
Use of Money Flow Index
As regards the use of the MFI tool, it is identical to the RSI. The Money Flow Index can be used as an index showing when the market is oversold and overbought. When the MFI index is above the overbought level, which is above 80, it means that the market is already “swiveled” and it is a signal to take short positions. When the MFI is below the oversold level, i.e. it falls below the 20 level, the market is undervalued and it is a signal to take long positions..
Another way to use the Money Flow Index is to look for a divergence in order to estimate the momentum of a trend change. The rising price of the instrument when MFI readings are falling in the overbought area is a strong signal to begin the downward trend. The increase in the value of the MFI positioned in the oversold area when the price is falling is a signal to take long positions.
Money Flow Index is a useful but somewhat underestimated indicator of technical analysis. It is a solid technical analysis tool, definitely worth the attention, but its major disadvantage is the relatively small number of transactional signals – but there is a plus – it generates little noise in more complex transactional systems. Volume indexes AD, OBV and MFI are quite similar, and it is hard to tell which one is better for everyday trading. This is a question of investor’s beliefs and experiences. You will certainly not waste time checking the functionality of these indicators, so we leave the choice of the best index to you.
Advantages of Money Flow Index
- Clear buy and sell signals
- Ease of use regardless of the manner of use
- Ability to include the index in a wider strategy
Drawbacks of Money Flow Index
- Low amount of signals