MFI INDICATOR - STRATEGY FOR TRADING

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Indicator MFI — model


  • Incorporating technical indicators into your trading system requires a clear understanding of their fundamental principles.


An innovative solution developed by Gene Cuong and Avrum Sudak allows the use of volumetric data in metric analysis.

The Cash Flow Index serves as a graphical representation of the "cash ratio", requiring a preliminary derivation of the "cash ratio" and subsequent calculations, including the determination of typical price and cash flow.
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Similar to the relative strength index, the cash flow index is based on the concept of a “typical price,” calculated as the average of the high, low, and closing prices over a specified period of time. For example, if the daily time frame has a high of 70,000, a low of 65,000, and a closing price of 68,000, the typical daily price is calculated as follows:

Typical daily price = (70000 + 65000 + 68000)/3 = 67666


Cash flow is then determined by multiplying typical price by volume:

Cash Flow = Typical Daily Price * Volume.


Comparing the resulting cash flow with the previous day's cash flow makes it easier to identify positive or negative trends. Positive cash flow indicates an increase, while a negative cash flow indicates a decrease. Cases of equivalent cash flow values are not taken into account.

When positive and negative cash flows can be distinguished, the cash ratio is calculated by dividing the former by the latter:

Cash Ratio = (Positive Cash Flow / Negative Cash Flow).


Using this data, the cash flow index (MFI) can be calculated using the formula:

MFI = 100 - (100/(1 + Money Factor)).


Gene Cuong and Avrum Sudak have delineated three primary signals employed by the Cash Flow Index:

  1. Overbought or Oversold Levels: Traders strategically monitor for overbought or oversold conditions as indicators of unsustainable price extremes, signaling potential market corrections.
  2. Bullish and Bearish Divergences: Analysis of bullish and bearish divergences serves as a predictive tool for identifying potential trend reversals. Discrepancies between the direction of price movements and corresponding Cash Flow Index trends can offer valuable insights into shifting market dynamics.
  3. Fluctuations at 80 or 20 Levels: Observing fluctuations in the indicator readings around the 80 or 20 thresholds enables traders to discern potential market reversals. These pivotal levels serve as crucial points of reference, guiding traders in assessing market sentiment and making informed trading decisions.


Determining overbought and oversold zones using the cash flow index


While the relative strength index (RSI) and other oscillator-type technical indicators are capable of identifying overbought and oversold market conditions, the money flow index (MFI) stands out for its effectiveness in this area. Including additional volume information allows the MFI indicator to filter out false signals from overbought and oversold conditions, increasing its reliability, especially for traders looking to counter prevailing trends.

Like most momentum indicators, the Money Flow Index ranges from 0 to 100. A Money Flow Index reading below 20 indicates an oversold signal. Conversely, a Cash Flow Index reading greater than 80 suggests an overbought scenario.
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One limitation of trading based solely on overbought and oversold signals is the inability to counter the current trend merely due to signals generated by the Money Flow Index (MFI). Optimal trading strategy involves exercising patience and waiting for a price action pattern to validate a shift in the prevailing trend before taking a position. By employing this approach, traders can make more informed decisions and reduce the risk of entering positions prematurely based solely on MFI signals.

The MFI Indicator and Divergence


Beyond its function in pinpointing overbought and oversold conditions, the Money Flow Index (MFI) indicator serves as a valuable tool for detecting divergence within the market. In essence, divergence manifests when the price moves in one direction while the indicator readings depict a contrary trend. Traders regard this occurrence as a strong indication that the price is poised to reverse in alignment with the technical indicator's trajectory.

Utilizing the MFI indicator enables traders to readily recognize such signals, whether they manifest as bullish or bearish divergence.

Bullish Divergence:
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Bearish divergence:
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What Should You Consider?


By integrating volume into its mathematical framework, the Money Flow Index is adept at generating highly precise trading signals concerning overbought and oversold market conditions. Additionally, it demonstrates a notable ability to pinpoint emerging divergences within the market. However, like any technical indicator, it possesses inherent limitations.

A primary constraint of the Money Flow Index is its propensity to persist in overbought or oversold states for extended durations, potentially leading to false signals. Yet, by crafting a trading strategy that incorporates price action signals, traders can harness the MFI indicator to identify potential reversal zones.

Armed with this insight, traders can anticipate shifts in directional price movement with ease and strategize their trades accordingly.

Summing It Up:


The Money Flow Index stands out as a unique indicator amalgamating momentum and volume within the RSI formula. Its strength lies in its adeptness at identifying potential reversals through overbought or oversold levels, as well as bullish or bearish divergences. Nonetheless, prudent utilization of the Cash Flow Index entails supplementing its readings with additional technical indicators rather than relying solely on its signals.

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With the right approach and taking into account the context, the tool becomes very effective and useful
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Effectively depicting oversold conditions, the Money Flow Index serves as an excellent supplementary tool for enhancing the likelihood of successful transactions.
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Consider this example: A bearish divergence is observed in the market, indicating a potential reversal. However, the Money Flow Index (MFI) does not reach the oversold zone, stopping instead at 80. Nevertheless, upon examining higher timeframes, such as the weekly chart, it becomes evident that a significant imbalance has been filled. This imbalance serves as one of the confirmations suggesting that the price is likely to decline further. In this scenario, the combination of the bearish divergence and the fulfillment of a significant imbalance on a larger timeframe strengthens the indication of a downward movement in price, augmenting the likelihood of a successful transaction.
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These indicators also work well on lower timeframes - like 1 hour
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Good context is a good indicator
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Example with divergence, overbought and retest support zone
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Accurate contextualization significantly enhances the potency of the Money Flow Index (MFI) tool.
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Trust?
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