What Is a Money Flow Index (MFI)?
Developed by Avrum Soudack and Gene Quong, the Money Flow Index (MFI) is an indicator that measures buying and selling momentum of a financial asset using both volume and price action.
A rise in the usual price shows positive money flow, indicating purchasing pressure, while a fall in the price implies negative money flow, indicating selling pressure.
A money flow ratio, also known as a money ratio, is computed by summing positive and negative money flows.
Analyzing Bitcoin’s Price Extremes and Reversals
The money ratio assesses the MFI, which ranges from 0 to 100.
It can identify price extremes and reversals using volume and price signals.
The MFI chart shows that a reading above 80 means that Bitcoin (BTC) is oversold, and a price reversal to the downside can be expected.
However, if you go back a little, when BTC was in the 40k range,
the MFI indicator had a reading of 20 which meant that BTC is undersold in terms of price and volume. After that, it has only gone up and is now oversold on the daily chart.
Why Is Money Flow Index (MFI) Used?
The Money Flow Index is one of the most useful tools for analyzing a divergence in the chart of an asset.
When the MFI oscillator moves in the opposite direction of the price, it is called a divergence, implying that the current price trend is reversing.
Experienced traders avoid opening their trades when an asset is in the overbought territory due to the price reversal dangers.
MFI and the RSI are inextricably linked. However, they are not the same.
The key distinction is that, unlike RSI, the MFI technical indicator takes volume into account.
This is why many market analysts prefer MFI over RSI, as the former offers indications and warn of potential reversals more timely than the RSI indicator.
Interpreting the Money Flow Index (MFI)
The Money Flow Index (MFI) is a reliable indicator.
However, it can still offer misleading signals.
This usually happens because of the lack of movement in the price action of an asset in the buying window suggested by the MFI indicator.
Also, the MFI indicator may not offer consistent indications of price reversals, which is why a trader needs to use a variety of technical indicators such as relative strength index (RSI), Moving Average Convergence Divergence (MACD), on-balance volume (OBV indicator), Aroon indicator, stochastic oscillator, and others before making a buying or selling decision.