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Money Flow Index (MFI)
The Money Flow Index (MFI) is an oscillator that uses both price and volume
to measure buying and selling pressure. Created by Gene Quong and Avrum Soudack,
MFI is also known as volume-weighted RSI. MFI starts with the typical price
for each period. Money flow is positive when the typical price rises (buying
pressure) and negative when the typical price declines (selling pressure). A
ratio of positive and negative money flow is then plugged into an RSI formula
to create an oscillator that moves between zero and one hundred. As a momentum
oscillator tied to volume, the Money Flow Index (MFI) is best suited to identify
reversals and price extremes with a variety of signals.
Usage
As a volume-weighted version of RSI, the Money Flow Index (MFI) can be interpreted
similar to RSI. The big difference is, of course, volume. Because volume is
added to the mix, the Money Flow Index will act a little differently than RSI.
Theories suggest that volume leads prices. RSI is a momentum oscillator that
already leads prices. Incorporating volume can increase this lead time.
Quong and Soudack identified three basic signals using the Money Flow Index.
First, chartists can look for overbought or oversold levels to warn of unsustainable
price extremes. Second, bullish and bearish divergence can be used to anticipate
trend reversals. Third, failure swings at 80 or 20 can also be used to identify
potential price reversals. For this article, the divergences and failure swings
are be combined to create one signal group and increase robustness.
Overbought/Oversold
Overbought and oversold levels can be used to identify unsustainable price
extremes. Typically, MFI above 80 is considered overbought and MFI below 20
is considered oversold. Strong trends can present a problem for these classic
overbought and oversold levels. MFI can become overbought (>80) and prices
can simply continue higher when the uptrend is strong. Conversely, MFI can become
oversold (<20) and prices can simply continue lower when the downtrend is
strong. Quong and Soudack recommended expanding these extremes to further qualify
signals. A move above 90 is truly overbought and a move below 10 is truly oversold.
Moves above 90 and below 10 are rare occurrences that suggest a price move is
unsustainable. Admittedly, many stocks will trade for a long time without reaching
the 90/10 extremes.
The Money Flow Index is a rather unique indicator that combines momentum
and volume with an RSI formula. RSI momentum generally favors the bulls when
the indicator is above 50 and the bears when below 50. Even though MFI is considered
a volume-weighted RSI, using the centerline to determine a bullish or bearish
bias does not work as well. Instead, MFI is better suited to identify potential
reversals with overbought/oversold levels, bullish/bearish divergences and bullish/bearish
failure swings. As with all indicators, MFI should not be used by itself. A
pure momentum oscillator, such as RSI, or pattern analysis can be combined with
MFI to increase signal robustness.
Example
of Money Flow Index in PowerScan. It could be noted that the highest peak of
MFI (approaching 80) indicated an overbought condition, at which time, the stock
subsequently fell for over a week.
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