Money Flow Index is an oscillator indicator.
Money flow index indicator was created by Gene Quong and Avrum Soudack with the main objective of using price and volume to indicate whether the market is in an overbought or oversold condition
According to Gene and Quong, they consider it to have an oscillation ranges between 0 to 100 and oscillation points at 20 and 80 thus making it to become more similar to RSI indicator.The only difference is that in Money flow index,volume is considered to be very important while in RSI,volume is not considered to be very important.
Gene and Quong further derived the formula for calculating the values of Money Flow index as follows;
MFI=100-(100)/(1+MR)
Where ;
MR is money ratio given as;
MR = POSITIVE MONEY FLOW/NEGATIVE MONEY FLOW
Therefore, since money flow index is an oscillation ranging from 0 to 100 and oscillation points at 20 to 80 which make it similar to RSI, it, therefore, works on the basis of divergence and overbought and oversold in the market.
Concept of Divergence
For the case of divergence,when the price of the market is moving up while the MFI is falling,then a reversal of the price of the market will occur in the same direction to that of MFI,that is,it will start also falling, while if the price of the market is moving downwards while the MFI is rising, a reversal of the market will take place in the same direction to that of MFI,that is,it will start also rising. This is indicated from the candlesticks chart below;
From the candlesticks chart above, there is point A and Point B. Point is along the MFI while point B links upward and downward price. Initially, the price was moving downwards while the Money Flow Index was in an upward direction. The price then reverses and start moving upwards as the Money Flow index thus signaling the trader to exit a sell position and open a buy position.
Concept of overbought and oversold
For the case of overbought and oversold in the market, it follows the concept of RSI. That is,if the MFI falls below 20,then that will be an indication of an oversold in the market thus an upward market reversal will take place at that point thus signaling the trader to close any sell position and enter a buy position while if the MFI rises above 80, then that will be an indication of an overbought in the market thus a downward market reversal will take place at that point thus signaling the trader to close any buy position and enter a sell position .
This is indicated from the candlesticks chart below;
From the candlesticks chart above, there are 3 points,point A,B and C. Point A represents a point at which the MFI has fallen below 20 while point B is a point at which the MFI has risen above 80 and point C represents two red adjoining arrows which is representing the money flow index curve.
At point A where the MFI has fallen below 20, there is an oversold condition created at that point thus an upward reversal market will be created at that point. This will signal the trader to close any sell position at that point and enter a buy position since the market will start moving upwards.
At point B where the MFI has risen above 80, there is an overbought condition created at that point thus a downward reversal market will be created at that point. This will signal the trader to close any buy position at that point and enter a sell position since the market will start moving downwards.
Recommendation: If you are a day trader, just use 1 min,5 min,15 min and 30 min time frame while if you are a swing trader just use 1 hour and above time frame if you want Money Flow Index to work well for you
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