How do you know when a market is overbought or oversold? One indicator that can help you to visualize these conditions on your Forex charts is the Money Flow Index, often just called MFI for short.
This guide will teach you how to plot this indicator on your charts, how to interpret it, and how you can put it to good use while you trade.
The Money Flow Index is a type of oscillator designed by Gene Quong and Avram Soudack. It is weighted by volume.
To get money flow index manually, follow these steps:
Compute the positive money flow and the negative money flow separately.
If the typical price on a given day is higher than it was the day before, it is a positive money flow day. Add together the money flow for all such days to compute positive money flow.
If the typical price on a given day is lower than it was the day before, it is a negative money flow day. Add together the money flow for all such days to compute negative money flow.
There may be days where there is no typical price change compared to the previous day. You can ignore those days in your positive and negative money flow calculations.
The math above may seem like a lot of work, but when you use trading software like MT4, you will not need to worry about doing these calculations by hand. The trading platform will take care of all of the math for you.
When you plot it on your chart, you will see a line oscillating between 0 and 100, with additional horizontal lines drawn at 20 and 80. In terms of its appearance, it is quite close to the Relative Strength Index (RSI), a similar oscillator.
Key point: The Money Flow Index (MFI) is a kind of oscillator that ranges between 0 and 100.
The name “money flow index” describes quite well what it is the MFI is showing us. For the asset that you are looking at, you can see how money is flowing in and out.
The main utility of monitoring money flow in this fashion is that you can get a feel for whether the market may be overbought or oversold.
Sometimes, you can also spot reversals based on divergence.
Key point: You can plot the MFI on your charts to detect when an asset may be overbought or oversold.
Key point: You can quickly and easily plot the MFI on your charts.
There are a few ways you can make use of the Money Flow Index in your trading strategy:
Key point: You can use the MFI to determine if the market may be overbought or oversold, or to look for reversals in the market using divergences. Sometimes the MFI can also help you time your entry into trend trades by showing you when a retracement is done.
Key point: The Money Flow Index needs to be part of a tested, proven strategy if you want to put it to effective use.
The MFI can lend valuable context to your trading method, but isn't a trading method on its own. If you have been looking for a tool to add overbought and oversold context to your charts, help you spot potential reversals, and assist you in making sense of retracements, the Money Flow Index may be just what you are seeking.
Try adding the MFI to your chart. Train yourself to look for divergence, and watch the 20, 80, and 50 lines to keep track of buying and selling pressure. Incorporated into a reliable trading method, this oscillator can help you to get in on reversals quickly and maximize your profit potentials.
If you have any questions about the Money Flow Index indicator or if you just want to discuss its use in trading with others, you can proceed to our Forex forum.
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