What Is the Money Flow Index and How Does It Work?

Technical indicators are analytical tools in financial markets, helping assess potential price movements. The Money Flow Index (MFI) is a momentum oscillator that gauges the strength of money flowing into or out of a security. It integrates both price and volume data, offering a unique perspective on buying and selling pressure.

Understanding the Money Flow Index

The Money Flow Index is a volume-weighted oscillator, incorporating trading volume directly into its calculation. This differentiates the MFI from other momentum oscillators like the Relative Strength Index (RSI), which rely on price data alone. The MFI measures the strength of money flowing into or out of a security, providing insights into market conviction.

Money flow represents the amount of money used to purchase or sell a security. Higher money flow indicates greater buying interest; lower money flow suggests more selling pressure. The MFI ranges from 0 to 100, allowing for standardized interpretation across different assets and timeframes.

Calculating the Money Flow Index

The Money Flow Index calculation begins with the “Typical Price.” This value is derived by summing the high, low, and closing prices of a security for a given period, then dividing by three. The Typical Price represents the average price movement within that period.

Once the Typical Price is established, “Raw Money Flow” is computed by multiplying the Typical Price by the trading volume for the same period. Raw Money Flow quantifies the financial value of a period’s trading activity, reflecting the amount of money exchanged.

To refine the analysis, “Positive Money Flow” and “Negative Money Flow” are determined over 14 periods. Positive Money Flow accumulates Raw Money Flow when the current Typical Price is greater than the previous, indicating buying pressure. Negative Money Flow sums Raw Money Flow when the current Typical Price is less than the previous, reflecting selling pressure.

Following the aggregation of positive and negative money flows, the “Money Ratio” is calculated by dividing Positive Money Flow by Negative Money Flow. This ratio compares buying pressure against selling pressure over the chosen period. Finally, the Money Flow Index is derived using the formula: 100 – [100 / (1 + Money Ratio)]. This normalizes the Money Ratio into the 0 to 100 range.

Interpreting Money Flow Index Signals

MFI values provide signals for assessing market conditions and potential price reversals. A primary application is identifying overbought and oversold levels. MFI values above 80 indicate a security is overbought, suggesting excessive buying pressure and an imminent price pullback. Conversely, MFI values below 20 signal an oversold condition, implying strong selling pressure and a price rebound.

Another interpretation of the MFI involves identifying divergence between the indicator and the security’s price action. Bearish divergence occurs when the security’s price makes a new high, but the MFI records a lower high, suggesting weakening buying momentum despite rising prices. This foreshadows a downtrend. Bullish divergence appears when the security’s price makes a new low, but the MFI forms a higher low, indicating strengthening buying pressure that leads to an uptrend.

Beyond overbought/oversold conditions and divergence, the MFI confirms existing price trends. A rising MFI supports an uptrend, indicating money continues to flow into the security, validating upward price movement. A falling MFI confirms a downtrend, signifying money consistently flows out, reinforcing downward price action. The MFI’s effectiveness is enhanced when used with other technical indicators for comprehensive market analysis.