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In trading, tracking price movements manually across numerous assets can be challenging. The Money Flow Index (MFI) can help make this easier by acting as a volume-weighted technical analysis tool. It measures the strength of money flowing into and out of an asset, helping investors gauge market sentiment.
By understanding how to calculate the MFI you can identify reliable overbought and oversold conditions and anticipate potential price reversals.
Key Takeaways
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The Money Flow Index helps spot shifts in buying or selling pressure before stock prices make dramatic turns.
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MFI reveals hidden divergences between price and momentum, signaling early opportunities or potential trouble.
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Tracking MFI trends highlight deviations that often hint toward an upcoming price reversal.
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MFI makes it easy to monitor market mood by blending price and volume into one practical indicator.
What is the Money Flow Index?
When traders talk about what is money flow index, they’re referring to an indicator that blends price and volume to show how strongly money is entering or leaving a stock. Instead of looking at price alone, the MFI studies how much trading activity supports that movement.
It creates a score between 0 and 100, and that score helps traders judge momentum.
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If the reading climbs beyond 80, the market may be pushing the stock too high, too quickly.
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A fall below 20 often hints at heavy selling and a possible bounce ahead.
How to Calculate the Money Flow Index?
The Money Flow Index calculation involves four distinct steps:
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Calculate the Typical Price (TP): Typical Price = (High + Low + Close) / 3
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Calculate Raw Money Flow (RMF): Raw Money Flow = Typical Price x Volume
Calculate the Money Ratio:
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Positive Money Flow: Sum of RMF for days where Typical Price > Previous Day's TP.
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Negative Money Flow: Sum of RMF for days where Typical Price < Previous Day's TP.
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Money Ratio = Positive Money Flow / Negative Money Flow
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Calculate the MFI: Money Flow Index = 100 - [100 / (1 + Money Ratio)]
Typically, this is calculated over a 14-day period.
Advantages of Calculating the Money Flow Index
Calculating or keeping track of the money flow index can benefit you in several ways:
1. Identification of Overbought & Oversold Stocks
The price of any stock in the market is vulnerable to the forces of "pressure" and "inertia". A rising price may encourage more traders in the market to buy, which in turn causes the price to rise even more. However, as the price rises to an unsustainable level, the market slowly corrects course and smoothly arrives at a correct representation.
The MFI indicator can help you understand these pressures early. If the money flow index value rises above 80, the stock may be overbought and soon fall to a regular level. Similarly, if the money flow index value is lower than 20, the price of a stock is at a considerably low level and may be due for a rise.
You can use this data to identify extreme shifts in prices early and act on this information before the situation gets out of hand.
2. Identification of Divergence
The MFI indicator can sometimes move opposite to the stock price. These diversions can be of two types:
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Bullish: A very low money flow index reading climbs to above 20 while the stock continues to sell off, indicating a decrease in selling pressure. Buyers may soon rush into the market. It also presents you with a unique opportunity to buy securities at attractive prices.
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Bearish: A very high money flow index reading begins to fall below 80 while the stock price continues to rise, indicating an increase in buying pressure. The market may soon see a lot of sellers. In this case, by being an early mover by anticipating demand, you can receive more attractive prices for your stocks.
3. Failure Swing Detection
A failure swing is a strong signal of a price reversal that focuses specifically on the MFI indicator's movement in the overbought or oversold zones.
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Bullish Failure Swing: The MFI drops below 20 (oversold), bounces up, pulls back but stays above 20 (a higher low), and then breaks above its recent high. This signals buy momentum.
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Bearish Failure Swing: The MFI rises above 80 (overbought), drops, rallies but fails to cross 80 (a lower high), and then breaks below its recent low. This signals sell momentum.
Some traders also use the MFI indicator to locate larger divergences using the MFI & price data over a large period.
For example, let's say a stock you have been tracking peaks to a price of ₹500, falls to ₹480, and then rallies to ₹492. So, the stock has seen two successive highs of ₹500 and ₹492.
If the money flow index makes a lower high when the price reaches ₹492, it does not confirm the new high. This could foreshadow a coming decline in price.
The Difference Between the Money Flow Index (MFI) and the Relative Strength Index (RSI)
Here’s a comparison of MFI vs RSI:
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Money Flow Index (MFI) |
Relative Strength Index (RSI) |
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Uses both price and volume to judge how strongly money is entering or exiting a security. |
Tracks only price movement, measuring the pace of recent gains versus losses without factoring in volume participation. |
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Volume sensitivity helps MFI react early when buying or selling pressure quietly builds beneath the surface. |
RSI signals tend to appear slightly later because they rely solely on visible price momentum. |
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Often identifies potential reversals sooner, especially when volume leads price, which is helpful during shifting market phases. |
Works well during clean, steady trends but may overlook subtle accumulation or distribution phases. |
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Best suited for spotting turning points where volume strengthens or weakens a trend. |
Favoured for evaluating trend strength and identifying classic overbought or oversold zones. |
Read more about What is Relative Strength Index (RSI)?
Limitations of the Money Flow Index
There are a lot of factors that move a stock's price apart from the things that market data can predict. For instance, a sudden shortage of semiconductors or a natural disaster may impacts a company's facilities. So, the market divergence data based on the previous two weeks may not be accurate for making predictions for the next two weeks.
Conclusion
The Money Flow Index helps you understand market behaviour and read the signals hidden behind price and volume. It gives traders a clearer sense of whether money is quietly entering or exiting a stock, long before dramatic price swings show up on the chart. Since it merges two different data points, movement and participation, it often tells a more complete story than tools that track only price.
