Money Flow Indicator Explained: Meaning, Types & Uses

The good old bank passbook. It has all the entries of money credited and debited. By looking at it, you can understand when and how much money has come in and gone out of your account within a specific period.

However, what if you want to know how much money has flown in and out of a security over a certain time period? This is where a money flow indicator or money flow index indicator can help. So, what is this indicator and its various aspects? Let us find out.

What Is A Money Flow Indicator?

A money flow indicator is a simple tool that helps you understand the amount of money moving in and out of a stock. Think of it like this. When more people are buying the stock, money flows in. On the other hand, when more people are selling, money flows out of the stock.

The money flow index indicator looks at both price and volume. Price shows where the stock is heading. On the other hand, volume shows the number of people trading it. By combining these two, the indicator gives a clear picture of money flowing in and out of a stock.

Types Of Money Flow Indicators

There are different types of money flow indicators that you can use. These include:

Money Flow Index

The money flow index, or MFI, is an indicator that helps you understand if money is flowing in or flowing out of a stock. Its value moves between 0 and 100. If the value is usually above 80, it reflects that the stock may be overbought. On the other hand, if the value is below 20, it means that the stock may be oversold.

Chaikin Money Flow

The Chaikin Money Flow indicator is another common type of money flow indicator. By using a stock’s price, volume, and a time period (typically 21 days), this indicator gives you a number ranging from -1 to +1. If the indicator’s value is above 0, it means more buying is taking place. If the value is below 0, it means more selling is taking place.

Accumulation / Distribution Line

The Accumulation / Distribution Line, or the A/D line, is another common money flow calculator. It looks at where the stock closed during the day (whether at the top or bottom) of its price, along with the number of shares traded.

If the stock closes near its high price, it reflects active buying or accumulation. If the stock closes near its low price, it reflects active selling, and the A/D line moves down in such a scenario.

Volume Price Trend

The volume price trend is another common money flow index calculator. It helps you understand how price and trading activity move together. If a stock’s price goes up as many shares are being traded, it signals a strong upward move. On the other hand, if the price falls with heavy trading, it signals a strong downward move.

Money Flow Index Formula

There are several steps involved in calculating the money flow index formula. These include:

• Calculation Of Typical Price

To calculate it, find the average of the high, low, and closing price. The typical price formula is: (high + low + close) / 3.

• Raw Money Flow Calculation

It is the approximate amount of capital that passed through a stock within a given period. It is calculated by taking the typical price and multiplying it by the volume for that period.

• Calculation Of Positive And Negative Money Flows

Once you have calculated the raw money flow, you can determine if it is positive or negative. You can do so by comparing whether the raw money flow for a given period is higher or lower than the period before.

Next, you calculate the money flow ratio with this equation: positive money flow / negative money flow.

• Money Flow Index Calculation

Now you can find out the money flow index by using this formula:

MFI = 100 − [100 / (1 + Money Flow Ratio)]

How To Use Money Flow Index Indicator?

While the specifics may differ depending on the type of money flow indicator you use, here is how you can use it to your advantage:

Understand The Range

The indicator moves within a specific range, 0 to 100 (in the case of the basic index calculator). For instance, if the indicator reading is above 80, it reflects overbuying, which could potentially bring down its price. If below 20, it shows the stock may be oversold, which could result in a price rise.

Use It To Spot Buying And Selling Pressure

You can use the readings on the indicator to identify buying and selling pressure. For instance, if the reading drops below 20 and then starts to move up, it is an indication that the selling pressure might be easing. On the other hand, if the reading goes above 80 and then starts falling, it may indicate that buying pressure is easing.

Best Money Flow Indicator Strategy

While there is no best strategy as such, the right strategy is the one that allows you to:

• Gauge the overall trend of money coming in and out of a stock

• Confirm what you see

• Easily spot buying and selling opportunities

That said, even the best strategies are prone to failure. Therefore, you must always have a proper risk management mechanism in place, which can hold you in good standing even if something goes wrong.

Conclusion

The money flow indicator is a powerful tool that helps you understand the amount of money flowing in and out of a stock. When studied well, it can help identify buying and selling pressure and allow you to adjust your trading strategy accordingly.

Sources:

Investopedia

Britannica

IG