TECHNICAL ANALYSIS
Step Two After
FX
that, we
calculate what’s
called raw money flow (or simply money flow), which is a function of both volume and the typical price.
Money Flow = Volume x typical price
Step Three Fig. 1
The next step involves the ratio between the positive and negative money flow. This calculation is equal to:
Money Flow Ratio = (N-Day Positive Money Flow) / (N-Day Negative Money Flow)
N will be equal to the number of periods the indicator is set to. If kept to the default settings, N will be 14.
Positive money flow is calculated by taking the sum of all the money f lows on all the days in which the typical price of one day is above the previous day. Likewise, negative money flow is calculated taking the sum of all money flows on the days in which the typical price of one day is below the prior day.
Step Four
With those three calculations, the money flow index can be found according to the following formula:
Money Flow Index = 100 – 100 / (1+ money flow ratio)
As aforementioned, this value will always come to a value between 0 and 100.
It should be noted that on many charting platforms volume data is not kept for currency pairs. Without volume, the money flow index will not plot on the charts accordingly.
Using MFI for trading
Traders who use volume in their analysis often look for divergences between volume and price. If volume is trending one way, while price is trending in the opposite direction, it could be a leading indication of an upcoming change in the direction of the market.
Many technical analysts believe that price follows volume. Therefore, if volume is trending down while the
price trend is up, some traders will believe that price is likely to reverse trend to eventually match volume. Since the MFI integrates volume data into it, traders may attribute meaning to divergence between the direction of the indicator and price.
On the MFI, you can notice that there are green and red horizontal lines on the chart. The green line occurs at 80 while the red line occurs at 20. It is believed that when the MFI runs above 80 a security
is “overbought” while
when the indicator is below 20 a security is “oversold”.
Based on these two levels, traders would be biased toward long trades when a market is oversold and toward short trades when a market is overbought. Price reversals are, of
course, based on the premise
of mean reversion or distorted markets eventually working their way back to normality. If there is
FX TRADER MAGAZINE October - December 2018 53
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