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Money Flow Index
The money flow index is a measurement
that indicates whether money is flowing into or out of a stock. The basic
premise of the MFI is that if a stock closes up for the day, the money flow
is considered positive; investors are buying the stock and bidding up the
price. Conversely, if the stock closes down for the day, money is leaving
the stock, investors are selling, and it is considered a negative money
flow.
The index is charted on a standard
vertical/horizontal chart. The vertical scale is measured from 0 to 100,
while the horizontal axis measures the timeline. The MFI is best suited for
intermediate trends. As with most indexes and averages, the longer the
period the less volatile the results.
Below is a diagram of the MFI, using
JPM as an example:
Reproduced with
permission of Yahoo! Inc.
ã 2004 by
Yahoo! Inc.
YAHOO! and the YAHOO! logo are trademarks of Yahoo! Inc.
The objectives of using the MFI are:
·
To identify the top and bottom portions of trends. When the
index rises above the 80 level for a particular stock, it is considered
overbought. Conversely, when the index drops below 20, the stock is
considered oversold. Naturally, when the index is at the 80 or above level,
one needs to be very cautious if buying long. If the index falls below the
20 level, short purchases should be avoided.
·
To take advantage of stock price divergences from the
direction of the MFI trendline. This is a signal of a possible price
reversal, and the start of a new trendline.
·
To confirm the direction of a trendline. A slope trending
upward is bullish, while a downward sloping trendline is bearish. While
short-term positions normally follow the trendline, contrarian investors
often do very well betting against the trend in extreme market conditions.
The
technical analysts follow the trend, and trade in the direction of the trend
until a reversal signal is generated.
Don’t
necessarily sell a stock that goes to the 80 level. Good money can be made
at the market extremes. Technically, one should wait for a sell signal
before selling.
The MFI formula is a four-step
process:
Average Price = (High + Low + Close) /
3
Money Flow = Average Price X Volume
Money Ratio = Positive Money Flow /
Negative Money Flow
Money Flow Index = 100 – [100 / (1 +
Money Ratio)]
Where:
Positive Money Flow = Days that the
stock closed up from the prior day’s price
Negative Money Flow = Days that the
stock closed down from the prior day’s price
The MFI is considered similar to the
Relative Strength Index (“RSI”), since it measures the momentum of a
stock. The MFI takes the RSI concept to a more advance level, by factoring
in the effects of both price and volume to the trendline.
Understanding the flow of money is
always worthwhile and value-added information to investors.
Click below for more information on oscillators:
Rate of Change
Relative Strength Index
MACD
Price Oscillator
Stochastic
Williams %R
Volume + Moving Average
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