Money Flow Index Trading Strategy: Day Trading With MFI
The Money Flow Index (MFI) is developed by Avrum soudack and Gene Quong. It is a momentum oscillator, which measures the strength of money flowing in and out of a security. MFI is related to the Relative strength Index, but with the twist. Compared to RSI-it is only incorporates with prices, the Money Flow Index also incorporates with the Volume.
Money Flow Index (MFI): Formula and Setting
Money Flow Index Formula:
- Typical Price = (High + Low + Close) / 3
- Raw Money Flow = Typical Price ´ Volume
- Money Flow Ratio = (Positive Money Flow of 5 Periods) / (Negative Money Flow of 5 Periods)
- Money Flow Index = 100 – 100 / (1+ Money Flow Ratio)
The default setting for Money Flow Index is 14. You can use MFI with a setting of 5 in H4 and D1 timeframes.
How to Read Money Flow Index
- The current Typical Price is higher than the previous Typical Price – it is considered Positive Money Flow
- The Current Typical Price is Lower than the previous Typical Price – it is considered Negative Money Flow
- Positive Money Flow represent the sum of the Positive Money over the specified number of periods
- Negative Money Flow represents the sum of the Negative Money over the Specified number of periods.
How to Trade with Money Flow Index (MFI): Signals and Trading Strategies
- Money Flow Index (MFI) Overbought / Oversold Divergence Trading Strategy
The MFI indicator is quite similar to RSI, the indicator can be used in a similar manner. The MFI gives signals for overbought/oversold conditions and divergence.
When the MFI is above 90, the price of the stock is considered as overbought and a reversal or pullback. When the MFI is below 10, the price of that stock is considered as oversold and a reversal or pullback might occur.
It is important to note that when the market reaches overbought or oversold levels, it does not mean that market price will immediately reverse in the opposite way. During the strong uptrend or downtrend, markets can remain remaining in the overbought or oversold areas for long period.
Money Flow Index (MFI) Trading Strategy Rules:
- The Money Flow Index must reach an overbought or oversold area at least for one time.
- A divergence between the stock price and MFI must occur during the resent time period.
- Plot 200 – period EMA, which helps to identify the main direction of the market.
- If the price is trading below 200 EMA, only go with the short signals and if the price is trading above 200 EMA, then only go for long signals.
- It is very important to put stop loss. It should be placed above or below the recent make swing.
- Set minimum 2:1 Risk to Reward Ratio. Learn More: Capital Drawdown
As we can observe in above example,
- MFI reached in oversold area
- You can see the divergence between the MFI and the price.
- 200 – period exponential moving average was pointing upwards, indicates the bullish trend.
- Buy signal confirms after the price goes above the 200 – EMA.
Let’s Look at another chart, for SELL Trade:
As we can observe, the above stock gives the sell signal. In which MFI reached at least for one time in overbought area, and also, we can see divergence between MFI and Price & 200 -EMA confirms the sell trade.
Pros and Cons of MFI:
- Helps to identify the divergence on the chart – which is excellent.
- It is Useful for identifying overbought and over sold areas on chart.
- During the trending market condition, it works very well.
- It is lagging indicator that can produce numerous whipsaws if not used correctly.
- MFI does not contain all of the necessary data for proper analysis of price action, so it is advised to be used in combination with other indicators or Technical software.