The Money Flow Index (MFI) is an important yet low-profile tool for technical analysis, used for the generation of overbought and oversold trading signals. As with other oscillators (ROC, RSI), the MFI indicator is positioned between two major values (from 0 to 100), utilizing 90 and 10 levels to determine conditions of overbuying or overselling respectively.
MFI is based on volume and cost, signifying an opportunity for buying or selling assets at the right time. Traders can use it for defining divergences and to be aware when a change in trends is likely to occur.
MFI and other oscillators are most beneficial to traders when it may not be so easy to recognize a clear stock price trend. Generally, investors consider MFI one of the best tools, especially when combined with additional technical indicators (MACD, RSI, etc.).
What are Divergences on Money Flow Index Charts?
MFI charts can be daunting for newcomers, but they’ll start to make sense after a little analysis. And so will divergences.
What are divergences on MFI charts? Imagine that the Money Flow Index line shows a downtrend or an uptrend coinciding with a general movement in value. It’s a fairly simple situation, as you probably feel sure of the direction to follow.
The most advantageous way to employ this specific indicator is in an opposite situation, such as if you implemented Bollinger or MACD tools but felt unsure about what action to take next.
The divergence in this case potentially indicates a reversal for the prevailing trend or value, such as describing the situation in which the MFI follows a different path to the value of the asset itself.
For example, if the price of an asset increases but the Money Flow Index indicator drops, this could signal a potential bearish trend. On the other hand, a low Money Flow Index reading could begin to ascend but the asset continues selling off, which could be the start of a bull rally.
That’s how seeing divergence on an MFI chart could be a big benefit to traders.
Calculating the Money Flow Index
Calculating the Money Flow Index is simpler than you might expect. There are a few stages to complete, starting with defining the focus period and the TP (Typical Price) throughout this time frame.
The Typical Price formula would be: adding the asset’s highest value to its lowest price and to its close price for the focus time frame. Divide all by three.
After this calculation, you should define the Money Flow amount: Typical Price multiplied by Volume.
Next, you determine whether the money flow in the focus period is negative or positive. So, when today’s TP is below yesterday’s, this is a negative Money Flow. When it’s higher than the previous day’s, that’s positive.
The next stage in calculating the Money Flow Index is the money ratio, which involves dividing the positive MF by the negative MF.
Finally, we can work out the MFI via the following formula:
Money Flow Index = 100 – (100/ 1+ Money Ratio))
In cases with an MFI rising above 80 or dropping below 20, this could indicate a possible market peak or bottom.
Final Thoughts
To conclude, let’s summarize: the Money Flow Index is a technical indicator which cryptocurrency traders can leverage to create oversold or overbought signals. The formula described above is crucial to calculate the number and determine whether the market is bullish or bearish.
Traders tend to analyze Money Flow Index charts and watch out for the divergence that may indicate a trend or value’s reversal. Using MFI with additional crypto trading indicators can make for an effective combination.
Using the MFI indicator may help you recognize whether a move you’re considering is a smart one.
