The money flow index indicator is an oscillator that compares the positive and negative cash flows of an asset for a selected period. This technical indicator, in many ways, resembles the RSI oscillator but with a significant difference. The money flow index also takes into account the trading volume. It associates the concept of price with the money that formed the current price. In the Metatrader trading terminal, the money flow index indicator is displayed in the bottom of the price chart. It is a curved red line crossing levels 20 and 80, commonly known as oversold and overbought levels.
What is the Money Flow Index indicator?
It is believed that a usual price gives complete description of the process with the instrument rather than the closing price. The basic concept in calculating the money flow index will be money flow (cash flow), which is determined by the product of the typical price of the taken period by the trading volume for the specified period.
Money Flow (i) = Tp (i) * Volume (i),
Where,
Money Flow (i) is the amount of cash flow for the period,
Tp (i) is the typical price for the period,
Volume (i) is the trading volume for the period.
The next step is to assign the current cash flow to either positive (positive money flow) or negative cash flow (negative money flow). If the current typical price is higher than the previous one, then money flow is positive; if the typical price is lower, the cash flow value is attributed to negative.
At this stage, the money ratio (money ratio) is calculated as the quotient of dividing the number of positive cash flows for the specified period by the number of negative cash flows for the same period.
Money Ratio = ∑ (Positive Money Flow (i)) / ∑ (Negative Money Flow (i)).
The final step in calculating the indicator is to directly calculate the money flow Index as the difference of 100 and the quotient of dividing 100 by the amount of 1 and the money ratio.
Money Flow Index = 100 – (100 / (1 + Money Ratio).
It is worth noting that the money flow index does not include an averaging model in its calculation. The choice of a period is only a time interval, on which positive and negative cash flows are allocated for further comparison. Consequently, the money flow Index indicator is synchronous with the price, and in some situations, even faster.
If the asset rises in the current period, then the product of the typical price of the period and the trading volume is added to the value of the positive cash flow and the value of the money flow index increases.
If the price of the asset decreases, then the product of the typical price by the trading volume is added to the negative cash flow value, and the money flow index value decreases.
How to trade with the Money Flow Index indicator?
Like the RSI indicator, the money flow index provides three types of signals. These include an exit from the zones of the buying/selling order, divergence, and the formation of figures.
Since the money flow index is a typical oscillator, the most common signal will be the indicator line coming out of overbought/oversold zones. Moreover, when the trend begins, money flow index, like all other oscillators, is able to “stick” in the corresponding zone.
Therefore, this indicator needs a trend filter – a trend indicator like the Bollinger bands. Bollinger Bands will act as a trend indicator, showing the trend by tilting its middle line and filtering the money flow index (only buying with a rising middle line of Bollinger Bands and only selling with a decreasing one).
A transaction is executed at the moment the slope of the midline of the trend indicator changes, or when the price reaches the Bollinger border lines – provided that at this time there is an exit from the p / p zones according to the money flow index indicator. Stop orders are set at local extremes. And profit taking is carried out when changing the direction of the middle line of Bollinger Bands.
The most powerful signal for transactions is the money flow index indicator, forming a divergence with the price. This is the situation when, within the framework of the current trend, the price develops a new high/low, which is not duplicated by the extremes of the indicator. This signal is somewhat ahead of the character. A transaction is completed when the money flow index indicator line leaves the p / p zones with a stop order placed at the last local extreme.
Money Flow Index indictor strategy
The indicator in combination with Bollinger Bands can be applied to any pair on any timeframe. However, I personally prefer to use the 1-hour timeframe or higher as I find that this can reduce the false signals and means that less time is spent staring at charts.
Short selling
- Sell if the money flow index indicator is in overbought area
- The price should break below the middle line of Bollinger Band or touches the extreme of upper line.
- Keep the stop-loss slightly above the recent swing high.
- Take-profit I would wan to be at least twice the stop-loss.
Buying
- Buy if the money flow index indicator is in oversold area
- The price should break above the middle line of Bollinger Band or touches the extreme of lower line.
- Keep the stop-loss slightly below the recent swing low.
- Take-profit should again be at least twice the stop-loss.
The Bollinger Bands are just one way to filter money flow index trading signals. You can use any combination of technical indicators for your market analysis. moving averages are another popular indicator for identifying trending market conditions.
Money Flow Index conclusion
The money flow index indicator is a kind of RSI variation that takes into account trading volume. This is where the properties of this indicator come from. Since the volume value cannot be overestimated for asset analysis, the money flow index is often preferable for analysis than RSI.
The money flow index indicator is flexible to differing market conditions, thus can be used as part of a forex trend trading strategy and forex range trading strategy.
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