What is Money Flow Index?
The Money Flow Index can analyse the volume and price of currency pairs in the market. Identifying the trading volume helps traders receive signals about when a market can reverse or continue in the same direction, enabling them to take trading decisions accordingly. In our article, we will learn about the money Flow index in depth.
What is the Money Flow Index?
The Money Flow Index (MFI) is a technical volume indicator that provides traders information regarding the currency pair’s trading volume. It measures how much money flows in and out of a currency pair in the forex market over a specific period of time. The Money Flow Index indicator then tells traders if there is a higher buying or selling pressure in the market. The indicator oscillates between a range of 0 to 100 to provide overbought and oversold signals. The centreline oscillates around the number 50; buying pressure is indicated when it crosses 50, and selling pressure is indicated when it remains near but below 50.
- Any value equal to or above 80 signals overbought market levels.
- Any value equal to or below 20 signals oversold market levels.
MFI can either be positive or negative. Positive Money Flow is when a currency pair's current typical price (average of high price, low price, and closing price) is more than the previous typical price. The Negative Money Flow is when the current typical price of the currency pair is lower than the previous trading day’s typical price. When the sum of Positive Money Flow is divided by the Negative Money Flow, it is called the Money Flow Index ratio.
How to calculate MFI?
1. Calculate the typical price of the currency pair
As the first step to determine the MFI, you need to calculate the typical price of the currency pair, which is the average of the high price, low price and closing price. Hence, typical price = (high price + low price + close price)/3
2. Calculate the money flow of the specific period
Money Flow is calculated by multiplying the typical price with the currency pair’s trading volume in the market. Hence, Money Flow = Typical Price * Volume
- When the money flow is positive, it means that the buying pressure is high in the market and traders can enter long or buy traders.
- When the money flow is negative, it means that the selling pressure is high in the market, and traders can either exit the existing trades or enter short positions.
3. Calculate the Money Flow Ratio
Money Flow Ratio = sum of positive money flow over a specific period of time/sum of negative money flow over a specific period of time.
- The greater the Money Flow Ratio, the higher the buying pressure in the market.
- The lower the Money Flow Ratio, the higher the selling pressure in the market.
4. Determine the Money Flow Index
As the last step, traders need to calculate the Money Flow Index for a specific time period. The default time period set for the MFI is 14 trading days. The fixed minimum number is 0, and the fixed maximum number is 100. This leads to the MFI oscillating between 0 and 100, providing overbought and oversold signals. Money Flow Index = 100 – [100/(1+Money flow Ratio)]
How to trade with MFI?
You can trade the Money Flow Index with three trading signals –
Overbought and oversold market levels
As already discussed, any reading above or equal to 80 indicates an overbought market condition, implying selling opportunities. On the other hand, readings below or equal to 20 indicate an oversold market condition, implying buying opportunities. With the overbought and oversold market-level trading technique, traders seek the opportunity to enter or exit the market before the existing trend reverses.
A trending market refers to a situation where the currency pair’s prices close either higher or lower than the previous trading day prices in a series. A trend pullback is a pause in the trending market from recent peaks or troughs during a continued uptrend or downtrend, respectively. During a continued uptrend, when the Money Flow Index drops below 20 and retraces back up, it signals that the bullish trend is ready to resume. This signals traders to place long or buying orders in the market. Similarly, during a downtrend, when the MFI goes beyond 80 and drops thereafter, it confirms that the retracement has now ended, and prices are now going to continue in the bearish trend. This signals traders to enter short trades and exit existing long trades.
Divergence refers to the currency pair prices moving in the opposite direction of the Money Flow Index indicator.
- A bullish divergence takes place when the currency pair prices are trending lower, but the MFI indicator signals an uptrend.
- A bearish divergence takes place when the currency pair prices are trending higher, but the MFI indicator signals a downtrend.
When there is a bullish divergence in the market, it indicates high buying pressure and low selling pressures, implying traders place more long orders. On the other hand, the bearish divergence indicates high selling pressure and low buying pressure, signalling traders to place short or exit orders.
Start trading reversing markets with the Money Flow Index today
The MFI helps traders pick out ideal exit and entry price levels in retracing markets. Combining the MFI indicator with other retracing indicators helps confirm the reversal trends. Trade with Blueberry Markets to get access to tight spreads, advanced MT4, and MT5 platforms, and experiment with different indicators. Sign up for a live trading account or try a risk-free demo account.
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