Understanding Money Flow Index

The Money Flow Index, or MFI for short is a momentum based oscillator that was created Gene Quong and Avrum Soudack. The purpose of MFI was to measure the strength of institutional money flowing in and out of the security/instrument. It is quite similar to the RSI (Relative Strength Index) but differs in the fact that MFI also takes into account the volume, whereas RSI only considers the price.

The MFI is ideally suited for securities or instruments where volume plays an important role and one which is measured accurately. Therefore, the MFI is ideal for trading the equity or futures markets as compared to forex, where the aspect of volume is questionable.

Calculation of the Money Flow index

The MFI oscillates between 0 – 100 and is based on an ‘N-period’ where N could be days/hours or minutes depending on the time frame on which the MFI is plotted.

The Formula for calculating the MFI is quite simple. The MFI is derived as 100 – 100/(1 + Money Ratio)

  • Money Ratio = Positive/Negative Money flow
  • Money Flow = Typical Price (HLC/3) x Volume

Similar to the RSI, the MFI oscillates between a fixed range of 0 – 100 where MFI above 70 or 80 is considered overbought and MFI values between 20/30 is considered to be oversold. However, as with any indicator, trading should not be solely based on only one indicator which is true for MFI as well. When plotted on the daily charts for 14 days closing price, here is how the MFI looks:

Money Flow Index - Momentum Oscillator
Money Flow Index – Momentum Oscillator

MFI V/s RSI

There is a lot of debate and articles which is biased to the superiority of the MFI compared to the RSI. A primary reason why MFI trumps RSI indicator is that it also takes into account Volume. As we know that volume precedes price, the MFI is thus considered to be far superior to the RSI. However when plotted alongside the RSI, there isn’t much of a visible difference between these two indicators. In the chart below, we have a 14 day MFI and RSI indicator plotted alongside. With the exception of a few sharp troughs, the MFI acts quite similar to the RSI.

RSI - MFI Comparison
RSI – MFI Comparison

MFI Divergence Trading

For what its worth, the Money Flow Index makes for an ideal oscillator to spot divergence between price due to the fact that it considers the volume. The MFI, in aspect of divergence is more reliable than any other oscillator for this reason alone. Learn more about trading with divergence.

In the example below, we have AAPL daily charts plotted along with the MFI indicator. We notice a ‘classic bullish divergence’ in play. Early March, price made a higher low while the MFI logged a lower low. Subsequently, price made a new low in mid-April while the MFI indicator plotted a higher low.

Price eventually bounced off this low to push higher.

MFI Divergence Trading
MFI Divergence Trading

To conclude, the Money Flow Index is a versatile momentum based oscillator that is fairly better than using the RSI. Traders could very well apply the same principles of RSI to the MFI indicator along with using this indicator in conjunction with other indicators such as volatility or trend to be able to make better trading decisions.