How to apply the Money Flow Index indicator on Forex
Professional traders believe that the MFI (Money Flow Index) indicator is among the ten most popular technical analysis tools. This statement is based on the fact that MFI, by its nature, is quite indicative in calculating the flow of finances invested in a particular asset. How useful this indicator is in Forex, we will understand today by testing various options for its use.
Currency pairs: any
Trading time: around the clock
Recommended brokers: Alpari, RoboForex, Amarkets
The Money Flow Index (MFI) indicator shows the intensity with which money is invested in or withdrawn from a security. MFI is very similar in terms of operation and calculation to the RSI indicator, only it additionally takes into account the volume. In fact, this indicator measures the pressure of sellers and buyers. MFI is built in the basement of the chart and ranges from 0 to 100:
You can find this indicator in your MT4: Insert> Indicators> Volumes> Money Flow Index. On our forum you can choose a custom indicator from a large set, kindly created by Pavel888 forum member.
An unmodified indicator usually has only one setting - its averaging period, which, as a rule, is set to the same as that of the RSI - 14 indicator.
Principle of operation
The MFI indicator calculates the difference between incoming and outgoing cash flows. If the underlying value of the asset is lower than this difference, then this means that there is an increase in the incoming money supply and a bull market. If we see the opposite, then investors are leaving the instrument and the market is bearish.
Thus, the MFI compares the ratio of positive and negative cash flows. If the typical price for the current period is higher than for the previous one, this indicates a positive inflow of money into this asset. If the typical price for the current period is less than the previous one, then investors are withdrawing funds from this asset.
Like the RSI indicator, support and resistance levels fall at levels 30 and 70, or at 20 and 80. The recommended indicator period is 14, but you can choose the best option yourself.
The Money Flow Index uses the concept of a typical price in calculating - the quotient of dividing the maximum, minimum and closing prices by 3. The basic concept in calculating the Money Flow Index is Money Flow, which is determined by the product of the typical price of the period taken on the trading volume for the specified period.Money Flow (i) = Tp (i) * Volume (i),
where Money Flow (i) is the amount of cash flow for the period,
Tp (i) - typical price for the period,
Volume (i) - trading volume for the period.
The next step is to classify the current cash flow to either positive (Positive Money Flow) or negative cash flow (Negative Money Flow). If the current typical price is higher than the previous one, then Money Flow is positive, if less, it is negative.
At this stage, the money ratio (Money Ratio) is calculated as the quotient of dividing the amount of positive cash flows for the specified period by the amount of negative cash flows for the same period.Money Ratio = ∑ (Positive Money Flow (i)) / ∑ (Negative Money Flow (i)).
And at the last step - directly calculating the Money Flow Index, as the difference of 100 and the quotient from dividing 100 by the amount of 1 and the money ratio.Money Flow Index = 100 - (100 / (1 + Money Ratio).
It is worth noting that the Money Flow Index does not include an averaging model in its calculation, and the choice of a period is only a time interval, on which positive and negative cash flows are allocated for their further comparison. Therefore, the Money Flow Index indicator is synchronous with the price, and in some situations even faster.
Using Money Flow Index in Trading
Well, now let's move on to the most interesting question - how to use this indicator in trading? Since MFI is very similar to RSI, it provides three types of signals. These include exit from overbought / oversold zones, divergence and formation of figures.
Overbought / Oversold Levels
Since the Money Flow Index is a typical oscillator, the most common signal will nevertheless be the exit of the indicator line from overbought / oversold zones. Moreover, when the trend begins, the Money Flow Index, like all other oscillators, is able to get stuck in the corresponding zone for a long time. Therefore, the indicator needs a trend filter.
The traditional overbought territory starts above 80, and the oversold territory starts below 20. However, these values are subjective, and you can certainly set any threshold values that are best suited for this tool.
Intersection of the median line
If you draw a line at the level of 50% on the MFI chart, you can use its intersection as an additional confirmation signal.
The intersection of this level from the bottom up indicates increasing pressure from buyers and is a signal to buy. The intersection from top to bottom shows that sellers are gaining strength and now sell positions are in priority.
A MFI discrepancy occurs when there is a difference between what the price action indicates and what the MFI indicates. These differences can be interpreted as an impending U-turn. In particular, there are two types of discrepancies: bearish and bullish.
There is already a lot of information about divergences on our website (use the search in the upper right corner), so there’s no point in repeating it. This is a pretty powerful and accurate signal for any oscillator.
Sometimes a trading method is used, in which the indicator chart tracks resistance and support levels, trends and technical analysis figures, such as a double top or a head with shoulders. Especially reliable signals can be considered those that appear simultaneously on the indicator chart and on the price chart. This method of trading is quite specific, since much here depends on the subjective view of the trader and his interpretation of what is happening. I can only say that finding a good figure on the MFI chart is rather difficult.
I decided to test the development of simple indicator signals given at the intersection of overbought and oversold levels, as well as level 50. I took one EURUSD currency pair for the D1 period and several signal options. At the same time, I used various options for trailing stops, ATR stops and closing on various signals from other indicators. All parameters for exit and position tracking were optimized once when using the entry option for another indicator to exclude the adjustment of parameters to the specifics of the MFI indicator. Further, with these parameters, I conducted several tests without changing the indicator parameters.
Option 1 - buy if MFI (7) crosses level 30 from bottom to top, and sell when level 70 crosses from top to bottom:
Option 2 - reverse first option:
Option 3 - MFI rises for purchases and falls for sales:
Option 4 - MFI over 50 for purchases and less than 50 for sales:
Option 5 - MFI rises above 50 for purchases, falls below 50 for sales:
Option 6 is a reverse option (as option 2), but with a period of MFI 21:
The only normal way to use the overbought / oversold levels of the MFI indicator is the intersection of the overbought levels with the indicator from top to bottom for sales and the level of oversold from bottom to top for purchases, which is to be expected.
The Money Flow Index indicator is a kind of RSI variation that takes into account trading volume. This is where the properties of this indicator come from. Since the volume value cannot be overestimated for asset analysis, the Money Flow Index is more preferable for analysis than RSI.
The price of a financial instrument and its correlation with momentum are a very important indicator for any technical analyst. A cash flow index can be a very valuable tool. Of course, MFI should not be used as the sole source for signals, like any other indicator. Since this is an oscillator, it is logical to use it to determine a specific entry point, while determining the current trend using one of the trend indicators.