The Money Flow Index (MFI) is a technical indicator that measures the momentum and strength of a financial asset by tracking the inflow and outflow of money. It is often referred to as a volume-weighted Relative Strength Index (RSI) because it incorporates both price and volume data. The MFI is used by traders to identify overbought and oversold conditions, potential trend reversals, and price divergences.
Key Components of MFI:
Price: It uses the typical price, which is the average of the high, low, and closing prices.
Volume: Volume data is a crucial part of the calculation, giving more significance to price movements that occur on higher volume.
Calculating the Money Flow Index
- The calculation of the MFI involves several steps. The calculation begins by determining the typical price for the given period, which is the average of the high, low, and close prices. Typical Price = (High + Low + Close) / 3
- Then, the raw money flow is calculated by multiplying the typical price by the corresponding trading volume. Raw Money Flow = Typical Price * Volume
- Next, positive and negative money flows are distinguished based on whether the typical price is higher or lower than the previous period’s typical price.
- Positive Money Flow (PMF) is the sum of raw money flows on days when the typical price of current period is greater than the previous period’s typical price, while
- Negative Money Flow (NMF) is the sum of raw money flows on periods when the typical price is lesser than the previous typical price. (Note – If typical price is unchanged compared to previous value, then the Raw Money Flow is not used)
- The MFI is then calculated using the formula: MFI = 100 – (100 / (1 +( PMF / NMF)))
Interpreting the Value of the Money Flow Index (MFI)
If the positive money flow is greater than the negative money flow, the money flow ratio (PMF/NMF) is greater than 1. In this case, the Money Flow Index (MFI) is greater than 50. This is true in markets with uptrend. (Asset is making higher typical prices continously with high volume)
If the positive money flow is less than the negative money flow, the money flow ratio (PMF/NMF) is less than 1. In this case, the Money Flow Index (MFI) is less than 50. This is true in markets with downtrend. (Asset is making lower typical prices continously with high volume)
