Technical Analysis
The Money Flow Index
Now that we've taken a look
at the Relative Strength Index (RSI) , let's take a look at
a more stringent momentum indicator. The Money Flow Index measures
the strength of money flowing into and out of a stock. The difference
between the RSI and Money Flow is that RSI only looks
at prices whereas the Money Flow Index also takes volume into account.
Calculating Money Flow is a bit more difficult than the RSI:
First we need the average price
for the day:
Average Price
= |
Day High + Day
Low + Close |
|
3 |
Next we need the Money Flow:
Money Flow =
Average Price x Day's Volume |
Now, to calculate the money flow ratio you need to separate
the money flows for a period into positive and negative.
If the price was up in a particular day this is considered
to be "Positive Money Flow". If the price closed down
it is considered to be "Negative Money Flow".
Money Flow Ratio |
= |
Positive Money
Flow |
|
Negative Money
Flow |
The Money Flow Ratio is then used to calculate the
Money Flow Index:
Money Flow Index |
= 100 – |
100 |
|
( 1 + Money Flow Ratio ) |
|
The Money Flow ranges from 0 to 100. Just like the RSI, a stock
is considered overbought in the 70-80 range and oversold in
the 20-30 range.
The shorter number of days you use, the more volatile the Money
Flow will be. For the example below we will use a 14 day average.
 |
| This chart
was supplied by Barchart.com |
The chart above is for Home Depot (HD), the Money Flow Index
is identified by the green line. Notice that each time the Money
Flow dropped below 30, the stock began to rally. Furthermore,
each time the money flow rose above 70, the stock started to
sell off.
Like any indicator, this is not correct 100% of the time. In early October when the stock price dropped from around $55
down to $37 the Money Flow didn't detect a thing. Also remember
that Money Flow is useful to detect momentum but it can't predict
unsystematic risk .
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