The Money Flow Index (MFI) is a popular technical analysis indicator that uses price and volume to measure the evolution of money flows into and out of an asset and to identify the primary sentiment of investors (strength of buying or selling pressure). It is generally considered as a twin to the RSI indicator, but with volume included in its calculation. As such, it is a more complex and complete indicator.
The MFI is a bounded oscillator evolving between 0 and 100 can be used to highlight extreme price situations, including overbought areas (when the MFI hits above 80) and oversold areas (when the MFI drops below 20). As a momentum indicator, the MFI can also be used to identify trend changes through divergences between the indicator and the price of the asset on which it is based.
The calculation of the Money Flow Index is quite similar in nature to the Relative Strength Index. The first thing to do is to select a number of periods. Typically, the MFI is calculated over 14 candles, however, it is possible to augment or to reduce the number of candle to respectively produce more or less sensitive signals. Four steps are necessary in order to calculate the MFI indicator.
Here are the required formulas:
Typical Price = (High + Low + Close) / 3
Raw Money Flow = Typical Price * Volume
Money Flow Ratio = X Period Positive Money Flow / X Period Negative Money Flow
Money Flow Index = 100 – 100 / (1 + Money Flow Ratio)
The MFI can be used to identify potential entry and exit points in the cryptocurrency market. For example, when the MFI is above 80, it indicates that the market is overbought and a potential sell signal may be present. Conversely, when the MFI is below 20, it indicates that the market is oversold and a potential buy signal may be present.
As we have mentioned above, the MFI indicator gives oversold and overbought signals. If the MFI or Money Flow Index is above 80 – although this number is set arbitrarily -, then the asset would be considered overbought. The price rose too intensely, or for too long, indicating that the it may soon change direction. If the MFI is below 20 – then again, this number is set arbitrarily -, then the asset would be considered oversold. Conversely, the price dropped too intensely, or for too long, allowing traders to expect a trend reversal. Traders might choose other limits than 20 and 80 to produce signals. The further the limits are from 50, the rarer yet the stronger the signals are. 30/70 marks will produce more numerous but less accurate signals than 20/80 marks.
Divergences are a major concept in the interpretation of the MFI indicator and other volume indicators. A positive divergence occurs when the MFI rises while the price of the asset falls. Positive divergences suggest a probable bottom and a reversal of the stock’s trend.
A negative divergence is when the MFI falls while the asset’s price rises. This divergence suggests a probable top and reversal of the asset’s trend.
The 4h candlestick chart above is the ETH/USDT market, with the 14-period MFI line underneath. We can see that on the left hand side, the price continues to rise when the MFI slowly drops, creating a negative divergence. Predictably, the prices of the asset reaches a top before dropping. On the right hand side, the MFI is slowly going up while the price continues to drop. ETH eventually reaches a low, before turning bullish.
The Relative Strength Index (RSI) is a technical oscillator used to define the strength or weakness of price changes based on the closing prices of a recent trading period. Both the RSI and MFI provide overbought and oversold signals that can be used by traders to open and close positions. The difference between these two indicators is that the RSI does not take volume into account. This is why the MFI is often referred to as the volume weighted RSI. The MFI is considered to provide earlier signals than the RSI because it is a leading indicator. However, there is no consensus as to which indicator is better. Many traders use both to confirm signals.
Below the BTC/BUSD 1-day candlestick chart above are drawn the 14-period MFI line and the 14-period RSI line below it. We can see that the MFI generally enter its overbought and oversold zones earlier than the RSI. Thus, traders can spot MFI overbought or oversold signals, and wait for RSI to confirm the signal to enter long or short positions.
There are many different types of technical analysis tools and indicators that can be used to analyze the cryptocurrency market. Some of the most popular tools and indicators include the Relative Strength Index (RSI), Moving Average (MA), Bollinger Bands (BB), Parabolic SAR (PSAR) and Stochastic Oscillator (SO). Each of these tools and indicators can be used in combination with the MFI indicator to provide improved market analysis.