Have you ever wondered what causes the price action? According to experts, it is influenced by price movement and investor's needs (Demand and Supply). Therefore, how can we measure demand and supply? In the present, many indicators have been developed to measure price trends. One of them is the money flow index (MFI), which its meaning and functions will be discussed in this article.

Get To Know Money Flow Index

Money flow index (MFI) is an indicator that analyzes price trends and trading volume to find reversal points. In addition, this tool can help solve the problem of locating difficult-to-measure supply and demand zones. This tool was invented and developed by Gene Quong and Avrum Soudack.

Using MFI to Analyze

This indicator uses analytics similar to the RSI indicator. However, the difference between them is that MFI also takes trading volume into account. You can use money flow index (MFI) to analyze two things:

1. Overbought and Oversold

2. Divergence and Failure Swings

Using MFI to Indicate Overbought and Oversold Signals

- If MFI below level 20 is oversold, it means that the  price has a chance to increase.

- If MFI above level 20 is overbought, it means that the  price has a chance to decrease.

From the chart, you can see that the range where the MFI is above level 80 is overbought (Red zone). It is a warning signal that the price has risen too much and there is a possibility of a correction. When the MFI is below level 20, it is oversold (Green zone). It is a warning sign that the price has already decreased a lot and there is a chance that it will rise again in the future.

Using MFI to Indicate Divergence and Failure Swings Signals

Divergence and failure swings are signs of a price reversal.

Determining the Divergence 

The divergence occurs when the MFI rises above 80 in the first round but cannot go above 80 in the second round. More importantly, MFI will make new lows.

Determining the Bearish Failure Swings

The bearish failure swings occur when the MFI was below the level 20 in the first round but cannot go below the level 20 in the second round. More importantly, MFI will make new highs. If the divergence coincides with the failure swings, it is a good sign of the price reversal. Additionally, the following examples will help you gain a better understanding.

From the chart, it is a bearish divergence and a bearish failure swing. The pink line indicates a bearish divergence. The yellow line confirms the bearish failure swing that is entering the downtrend.

Conclusion

Money flow index (MFI) is used to analyze price and volume trends to identify reversal points. The calculation formula of MFI is similar to the RSI  indicator, but MFI will take trading volume into account. Therefore, you can analyze price trends more effectively by considering overbought, oversold, divergence, and failure swings. However, you can use more than one indicator to increase trading efficiency.

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