What is it?
The Money Flow Index (MFI) shows the strength of money flowing in and out of a security.
It is a momentum indicator that uses both price and volume to measure buying and selling pressure.
MFI is also known as ‘volume weighted RSI’. It is theorised that volume leads price (RSI already leads price), so it is thought that by incorporating volume this can increase the lead time. The indicator can be compared to price and used in the following ways:
- identify the strength or weakness of a trend
- help identify price reversals and extremes
How is it calculated?
The ratio of positive and negative money flow is used in the formula below to create an oscillator that moves between zero and one hundred.
Money Flow Index Formula
- Typical Price = (High + Low + Close)/3
- Raw Money Flow = Typical Price x Volume
- Money Flow Ratio = (14-period Positive Money Flow) / (14-period Negative Money Flow)
- Money Flow Index = 100 – [100/(1 + Money Flow Ratio)]
The money flow ratio in step three is positive when the typical price rises (buying pressure) and negative when the typical price declines (selling pressure). The MFI is often calculated using a 14 day period.
How do you read it?
There are three basic signals that can be using the MFI:
- Overbought or oversold levels
- Positive and negative divergences
- Failure swings
Overbought or Oversold Levels
Typically, an MFI above 80 is considered overbought and MFI below 20 is oversold. It should be noted that during strong trends the MFI can remain overbought or oversold. In some cases it may be more reliable to consider a move above 90 as overbought and a move below 10 AS oversold; it is rare for the MFI to reach these levels and so it can suggest the price movement is unsustainable.
Divergences and Failures
Failure swings and divergences can be combined to create more robust signals. A bullish failure swing occurs when MFI becomes oversold below 20, surges above 20, holds above 20 on a pullback and then breaks above its prior reaction high. A bullish divergence forms when prices move to a lower low, but the indicator forms a higher low to show improving money flow or momentum.