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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. ă 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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