What is an MFI indicator?
The Money Flow Index is a family of oscillators that shows the inflow or outflow of liquidity into the market in the form of an index. But what is the importance of examining the inflow and outflow of liquidity into the market?
According to economic theory of money supply, when the money supply in the market increases, the purchasing power will also increase in parallel, and as a result, sellers will not be willing to offer their assets at a low price. The unattractiveness of low prices for sellers, as well as the increase in demand from buyers, causes prices to rise, and as long as prices do not satisfy sellers, we will see an upward trend. This is also true in reverse; When liquidity leaves the market, demand in the market will naturally fall, and this will cause prices to fall.
We now examine this theory in the capital market; When an investment option is considered by market participants, over time a large amount of money will enter the market and prices will gradually rise. Withdrawal of money from the market can also create the opposite situation and ultimately lead to lower prices.
How to calculate the MFI indicator
The MFI indicator is very similar to the RSI indicator, except that the trading volume is also included in the MFI calculations. Some analysts believe that the MFI is exactly the same as the RSI indicator, except that the volume is also included in its calculations. The calculations of the MFI indicator are very simple and first the closed price (Close) is added to the highest and lowest price (High & Low) and will be divided into three, which is the result of the so-called typical price.
In the second step, the cash flow is calculated; Liquidity inflows are divided into three categories: positive inflows, negative inflows and neutral inflows:
- Positive cash flow: When the typical price is higher than yesterday’s price, in this case the cash flow is positive.
- Negative cash flow: When the typical price is lower than yesterday’s price, in this case the cash flow is negative.
- Neutral liquidity flow: When the typical price has not changed compared to the previous day, in this case, it is in a neutral state.
In the third step, the liquidity ratio will be calculated and this ratio will be obtained by dividing the cash flow from positive to negative.
Now all the data needed to calculate the MFI has been completed and we can easily calculate the liquidity flow index based on the following formula. Of course, it is emphasized that technical analysts have no need to calculate the MFI, and only to teach and better understand the subject, how to calculate it has been taught.
MFI indicator signal
The MFI indicator is very similar to the RSI. This indicator, like the RSI, fluctuates in the range of 0 to 100, and the two levels of 20 and 80 are the most important levels of this indicator. Zones above 80 are designated as the saturation zone for liquidity entering the market and zones below 30 are designated as the saturation zone for liquidity outflows.
MFI Indicator Sales Signal:
When the cash flow enters the market, the MFI chart index starts to grow and after passing the level of 80, it enters the saturation zone of liquidity inflow. Over time and as prices rise, the necessary incentives are created among suppliers, and over time we will see increased sales and liquidity out of the market. The sell sign will be highlighted when the MFI chart exits the saturated liquidity inflow area and breaks the 80 level from top to bottom. In this case, due to the outflow of liquidity, we will probably see the beginning of a downward movement in prices.
MFI indicator buy signal:
Increasing relentless sales and outflow of liquidity from the market over time reduces prices. Due to falling prices and rising value, the necessary incentive will be created among investors, and over time we will see the entry of liquidity in the market, which will lead to the movement of the MFI chart from the saturation of liquidity outflow to the equilibrium. So when level 20 is broken by the MFI line from the bottom up, we can consider it as a buy signal.
Divergence and convergence in MFI:
One of the positive features of the MFI indicator is the possibility of examining weakness in the process. This indicator, like the RSI, has a relatively high accuracy in detecting divergences at the bottom and peaks. Given the importance of examining divergence in indicators, MFI can be a great help in identifying trend strengths.