If this is your first time trading…
Simply looking at a clean chart and executing trades can be pretty daunting.
It’s unclear if this trend will continue or if the market is about to reverse.
I feel completely comrades.
So, in today’s guide, we’ll take a closer look at the money flow index so you can trade trend continuations and trend reversals like a pro.
You can see that:
- What is money flow index in trading
- Why You Should Start Using the Money Flow Index to Level Up Your Trading
- Avoid these common mistakes when using the Money Flow Index:
- How to use the Money Flow Index to never guess your trades again
let’s start.
What is money flow index in trading
The Money Flow Index (MFI) is a type of momentum oscillator.
As with any momentum oscillator, you can easily get a sense of when the price is overbought or oversold in a particular market.
but…
Deriving the value of MFI is not as easy as moving average.
If you’re interested, here’s how to derive it.
Typical price for the period = (Close + High + Low) / 3
Period Money Flow = Period Typical Price x Period Volume
Money Flow Ratio = 14 Periods of Positive Money Flow / 14 Periods of Negative Money Flow
Money Flow Index = 100 – [100 / (1 + Money Flow Ratio)]
That’s quite a bite, isn’t it?
do not worry.
You don’t have to memorize everything that doesn’t make much sense.
The important thing to know is that MFI takes volume data into account when calculating values. (More on this later.)
What does the Money Flow Index indicator look like?
If you have a TradingView, the money flow index with default settings looks like this:
And if you look closely, there are three parts:
- Overbought areas above MFI 80
- Midpoint of MFI 50
- Oversold Area Below MFI 20
Next…
Why You Should Start Using the Money Flow Index to Level Up Your Trading
By now you should have noticed that:
The Money Flow Index indicator is very similar to the Relative Strength Index (RSI) indicator.
Stacking both MFI and RSI on TradingView…
The difference is almost imperceptible.
However, there are some differences:
- The Money Flow Index (MFI) considers both volume and price data.
- On the other hand, RSI only considers price data.
This means that traders who usually include volume in their trading analysis will really like the MFI indicator.
On the other hand, if you are a trader who doesn’t care about volume and just wants to see price, the RSI indicator is a better choice.
true intentions…
None of these momentum oscillators are better than others.
Either one will get the job done.
However, if you are just starting out and need more conviction before making a trade, the Money Flow Index Indicator is for you.
Moving on…
Avoid these common mistakes when using the Money Flow Index:
Just because a money flow index takes volume into account and uses a slightly more complicated derivation method doesn’t make it an “improved version” of the RSI.
A common mistake new traders make is thinking that MFIs are the Holy Grail because they have volume data.
If MFI = 10 (oversold), blindly choose to buy; if MFI = 90 (overbought), blindly choose to sell.
The thing is…
You can’t just use the sunshine indicator as a “trading signal” thinking it will be profitable on a continuous basis.
A few other factors must be combined before you can start trading.
(More on that in the next section.)
Another common mistake new traders make is reading too much into every little peak and trough in the money flow index.
Their eyes focus on random areas of the chart and the MFI indicator, looking for any kind of divergence between price and MFI.
No need to do that.
To get the best risk reward:
Squint your eyes a bit and focus your analysis on the obvious peaks and valleys near the oversold and overbought areas.
Keep it simple and don’t overthink it.
Did you take it?
Moving on…
How to use the Money Flow Index to never guess your trades again
In this section…
Here are three main techniques you can use to incorporate money flow indices into your trading process.
- Using MFI midpoints for strong trend continuation
- Continue to trade healthy trends using MFI’s overbought or oversold areas
let’s start.
1. Use MFI midpoints to continue strong trends
Strongly trending markets usually have shallow retracements not exceeding 20MA.
In strong bullish market conditions, it is almost impossible for the money flow index to reach the oversold territory below MFI20.
What you can do instead is wait until MFI retests halfway point 50. Meanwhile, the price will drop slightly to form a bullish flag.
The entry trigger will be the closing price of the bullish candle and the entry will be at the opening price of the next candle.
You can then set a stop loss 1 ATR below the bullish low.
Next…
2. Use the MFI’s overbought or oversold areas to trade healthy trends or weak trend continuations
In a healthy or weak trend, the price usually shows a steep retracement up to 50 MA or even turns the previous resistance into support.
In such healthy bullish market conditions, we can expect the Money Flow Index to reach oversold territory at MFIs below 20.
You can then look for valid entry triggers, such as the resistance before turning into support or the closing price above the 50 MA.
Similarly, the stop loss can be 1 ATR below the recent swing low.
Conclusion
A quick recap of what I learned today.
- The Money Flow Index, like the Relative Strength Index, is a type of momentum oscillator.
- The Money Flow Index considers volume and price data, while the Relative Strength Index only considers price data.
- Avoid blindly entering positions because the MFI is oversold or overbought.
- Combine MFI with market structures and moving averages as part of your trading plan for high-confidence trades.
to you right now…
Have you used the Money Flow Index Indicator before?
How do you use it in your trading?
Let us know in the comments section below.