The money flow index, or MFI, is a momentum indicator that measures the flow of money in and out of a security over a specific time period. The money flow index is similar to the relative strength index, or RSI, but it adds the trade volume to the RSI’s price action analysis.

Calculating the Money Flow Index

The money flow index is generally calculated over a 14 day time span.

The MFI is calculated using a complex formula that accounts for both positive and negative money flows (volumes on days where the price is rising and on days when it is falling).

The result is a score between 0 and 100 that indicates the degree to which buying or selling pressure is flowing into a security’s trading.

Trading with the Money Flow Index

The money flow index is generally used by traders as a contrarian indicator.

When the money flow index is moving in the opposite direction of the price, this indicates a growing reversal that is likely to overpower the current price trend.

An MFI of 20 is usually considered as a signal that a security is oversold and an MFI of 80 signals that a security is overbought.

Momentum Indicators

Momentum indicators, such as the money flow index and the relative strength index, are considered to be pure measures of temporary market sentiment, which means that they are attempting to signal the temporary feeling of traders toward a security, as opposed to a security’s long term price action driven by fundamentals.

Most technical analysis attempts to identify common technical patterns that occur as a price reacts to fundamental factors, while momentum indicators are a pure measure of the current sentiment and emotion of market participants.

These psychological factors can have an extremely strong influence on a security’s price over the short term, which is why most momentum indicators use 5 to 14 days as their time frame.

Momentum indicators can either be used on their own or in addition to other indicators. Many traders use momentum indicators, such as the money flow index, as a check to ensure that current market sentiment either supports or rejects one of their trades.

Even when all other indicators point to a strong trade, a contrary sentiment indicator may signal that the trader should wait until market sentiment turns in their favor.

Final Thoughts

The money flow index, or MFI, is a momentum indicator that measures the recent price and volume trend for a security. The money flow index ranks a security on a score of 0 to 100, with a lower score indicating strong outflows of money and a high score indicating strong inflows of money.

Momentum indicators, such as the money flow index, are measures of pure market sentiment, divorced from other technical indicators and fundamental analysis. Therefore, they are often used as a complement to other forms of analysis to ensure that current market sentiment supports a trade.

However, some traders use indicators like the money flow index to trade on their own, choosing to trade purely on the current market sentiment.