Money Flow Index indicator or MFI indicator for short is the instrument that more applies to experienced traders. It refers to the type of technical oscillators that make it possible to evaluate the money outflow and inflow. In fact, it helps to measure price movement over the given period. The tool considers both price and volume to help traders assess the pressure on the asset or market they trade in.
Years of trading experience made it clear that the volume itself does not appear to be an ultimate gauge of momentum. Traders must keep an eye on the way markets react on price movements, changes and pivots. This is where the MFI indicator is capable of confirming the momentum down or upwards. In other words, we have a tool that helps us to identify the market sentiment.
The key challenge for traders who plan to use the Money Flow Index indicator is the fact that they will need to make all calculations themselves. It is not just the point or line that will show you the ultimate price spot with the best market entry or exit position. The good news is that the calculations are pretty simple.
Money Flow Index Indicator Explained
If you plan to use a money flow indicator, keep in mind that it is an oscillator. It displays calculations on a 0-100 scale. After you have completed all necessary calculations, you will get a figure that is plotted on the scale to help you identify the market oversold and overbought signals.
How to Read the Money Flow Indicator?
Reading the MFI indicator does not require special techniques or advanced knowledge. All you need is to keep in mind the following:
- If the indicator is plotted above 80, it generates the market overbought signal. In this case, the line will turn red.
- If the figure is plotted below 20, it is associated with the market oversold conditions. A trader will see a green line.
Now, let's see how we can use the Forex Money Flow Index indicator to measure the money inflow and outflow.
Tips to Use Money Flow Index Indicator
In theory, the MFI indicator works the following way: the above-mentioned levels and lines show that that price is about to reverse. Traders get ready to open a position and benefit from the momentum. But in real life, the situation is a bit more complicated.
The asset price and the MFI index itself can sometimes provide contradictory signals. This is what traders call a divergence. Imagine a price to make a new high while the indicator fails to reach a relevant level providing bearish divergence. Traders are sure a selling pressure is about to occur, but the price falls down instead with the MFI indicator's inability to follow that movement. As a result, we can observe a bullish divergence.
What's more, a divergence of any kind does not always mean price reversal. As we have stated earlier, the instrument may come up with false signals. In other words, a trader identifies a perfect trading opportunity while the price starts moving unexpectedly in another direction. This is where an effective risk management strategy will help you to prevent inevitable losses.
Money Flow Indicator Calculations
The money flow indicator calculation process involves several baseline stages.
- At the first stage, we will need to identify the typical price (TP) of the period.
- Then we need to calculate the Money Flow (MF) amount. The result is positive if the current price is higher than the TOP of the previous day. If the price is lower, the M is considered as negative. Both values refer to the period in question.
- The last stage is to calculate the money ration. To calculate MR, you need to divide the MF positive sum by the negative.