Money Flow Index Explained
The Money Flow Index (IMF) is a technical indicator that utilizes volume data and price in recognizing overbought or oversold signals in an asset. Also, it could be used to identify divergences, which warn of a trend alteration in price.
The oscillator is moving between 0 and 100. A reading above 80 is deemed overbought, and an interpretation below 10 is considered oversold. Even so, the levels 90 and 10 are also used as thresholds.
Calculating the Money Flow Index
The following are the several steps for calculating the Money Flow Index. It is recommended to do the calculation using a spreadsheet rather than by hand.
Step 1: Compute the typical price of each of the last 14 periods.
Step 2: For each period, spot whether the common price was higher or lower compared to the previous cycle. It will tell you if the raw money flow is positive or negative.
Step 3: Calculate the raw money flow by multiplying the classic price by volume for that specific period. Use negative or positive numbers depends on whether the term was up or down.
Step 4: Compute the money flow ratio by adding up all the positive money flows over the past 14 periods. Then, divide it by the negative money for flows for the same prior course.
Step 5: Calculate the Money Flow Index using by utilizing the ratio constituted in step four.
Step 6: Continue doing the calculations as each new period ends by only using the data from the last 14 periods.
MFI’s Usage
One major way to use the Money Flow Index is when there is a presence of divergence when the oscillator is traversing in the opposite direction of the price. It is a hint of a possible reversal in the prevailing price trend.
For instance, a very high Money Flow Index that starts to decline below a reading of 80 while underlying security continues to rise is a price reversal signal to the pitfall.
On the other hand, a very low MFI level that climbs above a reading of 20 while the implied security continues to sell off is a signal of price reversal to the upper side.
Also, traders are watching for larger divergences using multiple waves in the price and MFI. For example, a stock hit a peak of $10.00 but pulled back to the $8.00 level. Then, it rebounded higher to $12.00.
This means that the price has made two successive higher, which is at the zone of $10.00 and $12.00. If the MFI makes a lower higher when it reaches $12.00, the oscillator is not confirming the new high. Accordingly, it could indicate a plunge in price.
Furthermore, the overbought and levels are used to indicate a possible trading chance. It is believed that movements below 10 and above 90 are rare. Besides, traders observe for the MFI to move back above 10 to indicate a long trade and plummet below 90 to signal a short trade.
