Analysing the stock market and the price movement is the starting point for investing or trading. The road to this process goes through using several technical analysis indicators and understanding chart patterns. A popular name in this category is the Money Flow Index indicator. Check out this blog to learn all about this indicator and how to use it for successful trading.
The Money Flow Index (MFI) is a tool used by traders to understand whether money is flowing into or out of a stock or asset. It is a stock market indicator that helps investors understand whether money is flowing into or out of a particular stock or market. It was developed in the early 1990s by Gene Quong and Avrum Soudack, two financial analysts, as a way to combine both price movement and trading volume into a single tool. Unlike many indicators that only look at price, the MFI also considers how much of the stock is being traded, making it more reliable for spotting real buying or selling pressure.
The Money Flow Index assigns values ranging from 0 to 100 to a stock or asset to determine the overbought or oversold condition. This tool can be especially helpful in developing markets because it gives a clearer picture of investor behaviour in markets that can sometimes be highly volatile. This indicator is similar to another popular technical analysis indicator, the https://www.truedata.in/blog/what-is-Relative Strength Index.
The Money Flow Index (MFI) is calculated in a step-by-step way that mixes both price and volume of a stock, so that investors can see if money is really entering or leaving the market.
The steps for the same are highlighted below.
The first step is to calculate the Typical Price (TP) by taking the average of the day’s High Price, Low Price, and Closing Price.
Typical Price (TP?) = (High? ?+ Low? ?+ Close?) / 3
The next step is to calculate the Money Flow, which is the product of the TP and the Traded Volume.
Money Flow (MF?) = Typical Price (TP?) * Volume?
This is followed by classifying each day’s money flow as Positive or Negative by comparing today’s TP with the previous day’s TP.
If TP? > TP?? ? ??
PMF? = MF? ; NMF? = 0
If TP? < TP?? ? ??
PMF? = 0 ; NMF? = MF?
If TP? = TP?? ? ??
PMF? = 0 ; NMF? = 0
The next step is to calculate the sum of all the positive MFs and all the negative MFs for the ‘N’ period, which is usually 14 days.
Traders need to calculate the Money Ratio (MR), which is the ratio of the total Positive MF and the total negative MF. If the total negative MF is 0, then consider MR to be a very large number, which effectively indicates a strong buying signal.
MR = PMF? / NMF?
Finally, calculate the Money Flow Index (MFI) using the following formula,
MFI = 100 - [100 / (1 + MR)]
Or
MFI = (100 * PMF?) / (PMF? + NMF?)
Interpretation of the MFI
If the MFI is above 80, it is an overbought condition where the buying pressure is strong.
If the MFI is below 20, it is an overlord condition where the selling pressure is strong.
Let us understand the calculation of the MFI using a simple example for better clarity and implementation.
Consider the following stock data of ABC Ltd. during a period of 5 days.
Step 1 = Calculate the Typical Price (TP)
Day 1 - (110+100+105)/3 = 105
Day 2 - (115+105+110)/3 = 110
Day 3 - (120+108+115)/3 = 114.33
Day 4 - (118+107+112)/3 = 112.33
Day 5 - (122+110+120)/3 = 117.33
Step 2 = Calculate the Money Flow (MF), where MF = TP * Volume
Day 1 - 105 * 1,000 = 105,000
Day 2 - 110 * 1,200 = 132,000
Day 3 - 114.33 * 900 ≈ 102,897
Day 4 - 112.33 * 1,100 ≈ 123,563
Day 5 - 117.33 * 1,500 ≈ 175,995
Step 3 = Classify into Positive or Negative Money Flow by comparing today’s TP with yesterday’s TP.
Day 2 - TP rose (110 > 105), hence, PMF = 132,000 ; NMF = 0
Day 3 - TP rose (114.33 > 110) hence, PMF = 102,897 ; NMF = 0
Day 4 - TP fell (112.33 < 114.33) hence, PMF = 0 ; NMF = 123,563
Day 5 - TP rose (117.33 > 112.33) hence, PMF = 175,995 ; NMF = 0
Step 4 = Add up Positive and Negative Flows (over 4 days here, Day 2–5).
Positive Money Flow (PMF) = 132,000 + 102,897 + 175,995 = 410,892
Negative Money Flow (NMF) = 123,563
Step 5 = Calculate Money Ratio (MR), where MR = PMF? / NMF?
MR = 410892 / 123563 ≈ 3.32
Step 6 = Calculate Money Money Flow Index (MFI)
MFI = 100 - [100 / (1 + MR)]
MFI = 100 - [100 / (1+3.32)] = 100 - (100/4.32) = 100 - 23.15 = 76.85
Interpretation of the above MFI
The MFI ≈ 77 for this 5-day period. Since it is close to 80, it suggests that ABC Ltd. is getting heavily bought (possible overbought condition). Traders might take this as a warning that the stock could face selling pressure soon, unless strong momentum continues.
The Money Flow Index is an oscillator indicator that can give insight into the overall market sentiment or collective market behaviour. This can be used as an effective trading signal to navigate the portfolio and capitalise on market movements or avoid potential losses.
The steps for trading using the Money Flow Index are outlined below.
Identify Overbought Zones (MFI above 80)
If the MFI moves above 80, it shows strong buying pressure.
Traders may treat this as a warning that the stock could be overbought and may face selling soon.
Some traders wait for the MFI to come down below 80 before considering a sell or short position.
Identify Oversold Zones (MFI below 20)
If the MFI moves below 20, it shows heavy selling pressure.
This suggests the stock might be oversold and could bounce back.
Traders may look for buying opportunities once the MFI crosses back above 20.
Look for Divergence with Price
If the stock’s price is making new highs, but the MFI is not, it signals that money is not truly flowing in (possible weakness).
If the stock’s price is making new lows, but the MFI is rising, it signals hidden strength (possible bounce).
Traders can use this mismatch as an early clue for a trend change.
Confirm with Trend and Volume
MFI should not be used alone and can be combined with trend indicators like moving averages, RSI, or MACD for better accuracy.
For example, if the price is above a moving average and MFI is rising from oversold, it strengthens the buy signal.
Use 50-Level as a Midpoint Guide
If the MFI is above 50, it generally shows that money is flowing in (buyers are stronger).
If it is below 50, it shows that money is flowing out (sellers are stronger).
Traders can use this as a quick check of market strength.
Best for Swing Trading and Short-Term Trades
Since the MFI considers price and volume over several days, it is most useful for short to medium-term trading. Traders often apply it to swing trades (holding for a few days) or positional trades (holding for weeks). It may not be very reliable for quick intraday moves, where price fluctuations are sharp and sudden.
The pros and cons of using the Money Flow Index are tabled below.
The Money Flow Index can also generate bullish and bearish signals in failure swings as well as divergence. These signals and their interpretation are explained below.
A failure swing happens when the MFI enters the overbought (above 80) or oversold (below 20) zones and then fails to continue in the same direction. Failure swings show that the market tried to continue in one direction but failed, giving a clue of a reversal. Thus, this failure itself creates a trading signal.
Bullish Failure Swing (Buy Signal) -
This happens when the MFI falls below 20 (oversold), then moves up above 20, comes down again but fails to drop below the earlier low, and then rises again. This pattern shows that selling pressure is losing strength. The buyers are starting to come back, and this is often seen as a buying opportunity.
Bearish Failure Swing (Sell Signal) -
This happens when the MFI goes above 80 (overbought), then falls below 80, tries to rise again but fails to cross the earlier high, and then starts falling. This indicates that the buying strength is weakening, and sellers are likely to take control, which is often taken as a signal to sell or book profits.
Divergence happens when the stock price and the MFI move in opposite directions. This mismatch warns traders that the current trend may not be reliable. Divergence tells the trader that the visible price trend is not fully supported by money flow, and a reversal may be near.
Bullish Divergence (Buy Signal) -
If the stock price makes a new low but the MFI makes a higher low, it means that even though prices are falling, the selling pressure is actually reducing. This can be an early indication that the stock is poised to rebound, which is a bullish signal to consider buying.
Bearish Divergence (Sell Signal) -
If the stock price makes a new high but the MFI makes a lower high, it means that even though the price is rising, money is not flowing in strongly. This weakening buying pressure can lead to a downward reversal, which is a bearish signal to prepare for selling.
The Money Flow Index is a useful tool for traders as it combines both price and volume to show whether money is flowing into or out of a stock. It works like a market thermometer, helping to spot overbought zones (above 80) and oversold zones (below 20), as well as hidden signals through failure swings and divergence patterns. Its strength lies in giving early warnings of possible reversals and confirming market strength. Thus, the Money Flow Index helps traders make smarter buy and sell decisions by showing the real flow of money behind price movements.
This article is another addition to our technical indicator series, where we attempt to simplify the technical jargon of stock markets. Let us know your thoughts on the topic or if you have any queries on the same, and we will address them soon.
Till then, Happy Reading!
Read More: Moving Average Crossover Strategy
Marisha Bhatt is a financial content writer @TrueData.
She writes with the sole aim of simplifying complex financial concepts and jargon while attempting to clarify technical and fundamental analysis concepts of the stock markets. The ultimate goal is to spread vital knowledge and benefit the maximum audience. Her Chartered Accountant background acts as the knowledge base to help clarify crucial concepts and create a sound investment portfolio.
The world of trading is constantly evolving with the use of advanced technology ...
Technical analysis in stock markets is like playing a complex game with many rul...
The backbone of successfully navigating options trading is accurately understand...
