In the family of oscillators, such as RSI, ROC or stochastic oscillator, MFI (Money Flow Index) is a low-profile, yet important, technical analysis tool used to generate overbought or oversold signals.
Just like with other oscillators, analysts place the MFI indicator between two extreme values from 0 to 100 and use 90 and 10 levels to identify overbought or oversold conditions, respectively.
Compared to other oscillators, Money Flow Index uses price and volume to signify a sell or buy opportunity for an asset. Traders implement it to define divergences, which alert them to be prepared for a trend change.
Oscillators, such as MFI, are most advantageous when it’s hard to spot a clear trend in a stock price. Investors find it one of the most important tools and combine it with other technical indicators, such as RSI, MACD, Stochastics and more.
In the pic, we can see how on Aug. 6, the blue line of the money flow index indicator is slowly climbing up towards 80, which coincides with the uptrend in the price of this asset and might signify a sell opportunity in the near future.
Let’s see what else this indicator tells you.
Divergence on the MFI chart
Let’s say the MFI line indicates an uptrend or a downtrend, and that coincides with a general price movement. In this scenario, everything is pretty straightforward, right? Because you know where things are going.
But the best way to use this particular indicator is actually quite an opposite situation. Say, you’ve implemented other tools, such as MACD and Bollinger, but still not sure about your next move.
The so-called divergence potentially identifies a reversal in the prevailing price or trend. In our case, it describes the situation where the MFI oscillator takes a different direction than the asset’s price.
These are two situations you will most likely observe when using this trading indicator.
The price of the asset goes up, yet the MFI indicator goes down, which potentially signals a bearish trend. Or, the other scenario: a very low MFI reading starts climbing up while the asset is still selling off. What’s going on? This might very well be the beginning of a bull rally.
So, this is how divergence presented on the MFI chart might be most advantageous for you as a trader.
Calculation of the MFI index
To understand how the index works, let’s see how we can calculate it. In order to calculate MFI, you need to go through several stages. First of all, analysts define the period in question and the typical price (TP) during this period.
TP = (High + Low + Close) / 3
To clarify the formula, High is the highest price of the asset, Low is the lowest price, Close is the close price of the period.
Then we need to define the amount of the Money Flow (MF).
MF = TP * Volume
Now, we need to see if the money flow for a selected period of time is positive or negative.
How can we do that?
If today’s typical price is lower than yesterday’s, the money flow is considered negative, and vice versa. But what about the money flow for the whole selected period? To get the answer, let’s sum up all the positive MFs as well as all the negative ones.
The next step in the calculation of MFI is the money ratio. Divide the positive money flow by the negative money flow.
MR = Positive MF / Negative MF
Now that we know the money ratio, we can calculate the Money Flow Index.
MFI = 100 – (100/ (1+MR))
That being said, the Money Flow Index indicator, climbing over 80 or falling under 20, identifies a potential peak or bottom of the market.
To sum up…
The MFI indicator is an oscillator or a technical indicator that traditional and crypto traders use to generate overbought or oversold signals.
To calculate the number, from 0 to 100, and see if it’s a bearish or bullish market, it’s necessary to apply the formula. There is a much easier way: use TradingView and analyze the MFI charts from there.
That being said, generally traders simply analyze the MFI charts and look for the so-called divergence that potentially identifies a reversal in the prevailing price or trend. It’s especially useful in combination with other trading indicators.
So you might want to apply this indicator when looking for one more proof to see if your potential move is right or wrong, to make sure the pullback is over, or to confirm a new high or low when multiple waves in price are observed.