Hello, dear friends. Forex market is a dynamic financial
market where global currency trading takes place. We trade in this market to
profit from changes in the prices of different currencies. However, the Forex market is quite complex and volatile. Therefore, we use various analysis
methods to predict price movements and make right trading decisions. Success in
financial markets relies on the ability to understand and forecast price
movements. Technical analysis is one method used for this purpose. This type of
analysis attempts to predict future price movements by examining past price
movements and trading volume. An important component of technical analysis is
technical indicators. These indicators are tools that process price data
through mathematical calculations. The topic of our current article is the
Money Flow Index (MFI) indicator, which is one of these technical tools.
What is the Money Flow Index (MFI)?
The Money Flow Index (MFI), or simply MFI, is a momentum indicator that measures the amount of money flowing in and out of a security.
In technical analysis, the Money Flow Index is often used to track a
combination of price movements and trading volume. This index is also preferred
for identifying overbought or oversold conditions of an asset and predicting possible
trend reversals. It achieves this by analyzing both price and volume. The Money
Flow Index (MFI) was first developed by Gene Quong and Avrum Soudack in 1997.
The invention of the MFI is a product of the work of these two financial
professionals in the field of technical analysis. This indicator has become
popular as a tool for examining price movements and trading volume in financial
markets and is widely used for identifying overbought and oversold conditions.
The studies conducted by Gene Quong and Avrum Soudack suggest that the MFI can
assist us in making decisions in technical analysis. MFI and RSI are similar,
but MFI analyzes price movements and trading volume at the same time, while RSI
only focuses on price movements.
Calculation of the Money Flow Index (MFI)
Money Flow Index (MFI), is like a thermometer that measures
the buying and selling pressure of an asset. By analyzing price movements and
trading volume, it tells us whether an asset is in overbought or oversold
conditions. The Money Flow Index (MFI) is calculated using price movements and
trading volume over a 14-day period. Here are the steps involved in its
calculation:
1. Calculate Typical Price (TP). First, the typical
price for each day is calculated. The typical price is the average of the high,
low, and closing prices and is calculated using the following formula:
TP = (High Price + Low Price + Closing Price) / 3
2. Calculate Money Flow. To calculate the money flow,
we need to determine whether the typical price for that day has increased or
decreased compared to the previous day. If there is an increase compared to the
previous day, it is considered positive money flow and is multiplied by the
day's trading volume. If there is a decrease compared to the previous day, it
is considered negative money flow and is also multiplied by the day's trading
volume.
Positive Money Flow (PMF) calculation:
PMF = TP × Daily Trading Volume (If TP increased, otherwise
0)
Negative Money Flow (NMF) calculation:
NMF = TP × Daily Trading Volume (If TP decreased, otherwise
0)
3. Calculate Money Flow Ratio (MFR). The money flow
ratio calculates the ratio of positive money flow to negative money flow and is
obtained using the following formula:
MFR = PMF / NMF
4. Money Flow Index (MFI) Calculation. Finally, the
Money Flow Index is calculated using the formula MFI = 100 - (100 / (1 + MFR)).
MFI = 100 - (100 / (1 + MFR))
When trading in the financial markets, there is no need for
us to perform these calculations manually. The indicator automatically
calculates them and presents the result both as a line and as a numerical
value. The most recent calculated value of the MFI, which is its current value,
is used to assess whether an asset is in overbought or oversold conditions.
When the MFI rises, it indicates an increase in buying pressure. When it falls,
it indicates an increase in selling pressure.
Trade with the Money Flow Index (MFI)
MFI is an effective tool for identifying overbought and oversold conditions. It is represented as a line that moves within a range of 0 to 100. When the MFI crosses above 80, it indicates overbought conditions. If the MFI falls below 20, it signals oversold conditions. The basic logic is that in overbought conditions, prices are likely to fall, so we would place a Sell order. In oversold conditions, prices are likely to rise, so we would enter a Buy order. You can see this in the example chart of the US Dollar/Singapore Dollar below:
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| Overbought and Oversold Trading with MFI in the USD/SGD chart |
However, it may not be effective when a strong trend is
apparent in the market or for determining long-term trends. During such times,
overbought and oversold signals may not always work correctly. For this reason, we do not use the MFI
indicator alone. We usually use it in conjunction with other technical
indicators that measure trend strength.
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| Divergence Trading with MFI in the USD/CNH chart |
Like other oscillators, you can also trade with divergences
in the Money Flow Index (MFI). If you encounter a negative divergence between
the oscillator and the price, you would enter a Sell order. If you come across
a positive divergence, you would enter a Buy order. You can see a clear example
of this in the chart of the US Dollar/Chinese Yuan pair above. In addition to
these, you can trade with all types of divergences in the MFI indicator.
Note that. Financial markets are full of
opportunities, but they also come with risks. To mitigate these risks, we use
technical analysis tools. However, in some cases, technical analysis tools may
be insufficient. To avoid this, it is often more effective to use indicators
like the MFI in combination with other technical analysis tools rather than
relying on them alone. Successful
trading!