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RSI vs MFI Trading Strategies (How to Trade with Money Flow Index) - YouTube
Channel: The Secret Mindset
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What moves markets?
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It's a fundamental question that every professional
trader should consider.
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Perhaps the shortest answer is supply and
demand.
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If demand for an instrument is high and supply
is short, the price will inevitably rise.
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If the converse is true, the price will fall.
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But how can we evaluate what is happening
with supply and demand?
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Especially in the forex market, which is de-centralized
and, not overly transparent.
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One method we can utilize is to use price
data to get a handle on how money is flowing
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in and out of an instrument.
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And one of the more popular tools for doing
this is the money flow index indicator.
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The money flow index (MFI) is a momentum indicator
that measures the flow of money into and out
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of a security over a specified period of time.
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It is related to the relative strength index
(RSI) but incorporates volume, whereas the
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RSI only considers price.
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For this reason, some analysts call MFI the
volume-weighted RSI.
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The MFI is calculated by accumulating positive
and negative money flow values, then creating
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a money ratio.
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The money ratio is then normalized into the
MFI oscillator form.
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The indicator is typically calculated using
14 periods of data and uses price and volume
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and the concept of accumulation distribution,
being quite helpful in confirming trends in
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prices and warning of potential reversals
in prices.
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So, how to read money flow index (MFI)
• when current typical price, meaning (high
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+ low + close) / 3 is higher than the previous
typical price, it is considered positive money
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flow
• when current typical price is lower than
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the previous typical price, it is considered
negative money flow
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• positive money flow represents the sum
of the positive money over the specified number
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of periods
• negative money flow represents the sum
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of the negative money over the specified number
of periods.
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• money flow index indicates the percentage
of positive money flow compared to the total
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money flow.
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MFI reading above 80 is considered overbought
and MFI reading below 20 is considered oversold.
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However, if you followed by channel you probably
know by now that overbought and oversold doesn't
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necessarily mean the price will reverse, only
that the price is near the high or low of
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its recent price range.
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The creators of the indicators recommended
using 90 and 10 levels as overbought and oversold
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levels.
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These levels are rarely reached, but when
they are it often means the price could be
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due for a direction change.
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The MFI and RSI are very closely related.
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The main difference is that MFI incorporates
volume, while the RSI does not.
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Traders relaying mainly on volume analysis
believe it is a leading indicator.
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Therefore, they also believe that MFI will
provide signals, and warn of possible reversals,
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in a more timely fashion than the RSI.
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One indicator is not better than the other,
they are simply incorporating different elements
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and, therefore, provide signals at different
times.
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But, as it incorporates volume, the money
flow index might give you the extra edge you
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need when you try to predict future price
movements.
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Ok, now let’s see how to trade with the
MFI indicator.
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As the money flow index (MFI) is quite similar
to RSI, the indicator can be used in a similar
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way.
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The MFI can offer traders several signals,
the main of them being overbought/oversold
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conditions and divergences.
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Moves below 10 and above 90 are quite rare.
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When the MFI is above 90, the price is considered
overbought and a reversal or pullback could
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potentially occur.
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When the MFI is below 10, the price is considered
oversold and a reversal or pullback might
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be recorded on the market.
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It is important to remember that simply because
a market reaches overbought or oversold levels,
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does not mean that prices will immediately
reverse in the opposite way.
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During periods of strong upward trends of
downward trends, markets can and will remain
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in the overbought or oversold areas for weeks
or even months.
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That’s why when the MFI hits or exceeds
values of 90 or 10, signaling overbought and
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oversold, you shouldn’t blindly enter counter
trend positions.
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You need to pay attention to price action,
to recent market swing, to key support and
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resistance levels and if you spot some sort
of confluence, then you should consider entering
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into a trade.
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The MFI should never be used on its own as
a trade signal, and must be used in conjunction
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with other tools of analysis to make better
informed trading decisions.
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Traders who use volume in their analysis often
look for divergences between volume and price.
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If volume is trending one way, while price
is trending in the opposite direction, it
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could be a leading indication of an upcoming
change in the direction of the market.
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For example, if the price is making new highs
and the MFI fails to make new highs, or falls.
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This is a bearish divergence and can be used
as a sell signal.
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Alternatively, if the price makes new lows
but the MFI fails to set new lows, or rises,
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this would be a bullish divergence.
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Since the MFI integrates volume data into
it, a divergence between the direction of
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the indicator and price could be a leading
signal.
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My preference is to combine these 2 approaches
to trade the money flow index (overbought
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and oversold levels and divergences) and merge
them into one signal, and further filter the
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signal with a trend line breakout.
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Here are the steps of this strategy:
First, the money flow index must reach an
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overbought or oversold area at least once
on the chart in the recent trading period.
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I use a 7-period MFI, and not the default
settings of 14 period.
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The 7 period MFI will have an increased sensitivity,
to produce more signals.
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The second step: a divergence between the
money flow index and the price must occur
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during the recent period.
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I prefer to identify the main trend with a
200-period exponential moving average and
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I only take signals in the direction of the
200 EMA.
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If the price is trading below 200 EMA, I plan
take only short signals.
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If the price is trading above 200 EMA, I take
only long signals.
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Then I search for entries once the price breaks
through a recent support or resistance level,
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a trend line or channel.
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As we can observe in this AT&T example, this
method offer several valid entries for buy
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positions as all our conditions were met:
Here’s our first signal:
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First, the 200-period exponential moving average
was pointing upward, indicating a bullish
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trend, so we take only buy trades
MFI reached an oversold area
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We have a divergence between the MFI and the
price.
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And the buy signal was confirmed after the
trend line was broken to the upside.
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The second signal appeared here, within the
same conditions.
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And another signal here.
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Your stops should be placed below the recent
market swing.
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And here are 2 short trades on Netflix.
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The first signal appeared here:
The 200-period exponential moving average
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was pointing downward, indicating a bearish
trend, so we take only short trades
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MFI reached an overbought area
We have a divergence between the MFI and the
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price.
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And the sell signal was confirmed after the
trend line was broken to the upside.
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The second signal appeared here, within the
same conditions.
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We have a double top in price, but lower MFI
readings, plus the overbought level and the
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trend line breakout.
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Here are other examples of valid trades, using
the money flow index.
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Another way in which you could use the money
flow indicator is to take signals when the
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oscillator crosses the 50 level.
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When money flow index crosses above 50 level,
this signals buying pressure coming into the
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market
When money flow index crosses below 50 level,
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this signals selling pressure
A 50-level crossover using the MFI with the
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default value of 14-period will offer some
good entries, but it also will generate many
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bad trades.
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The main problem with this method is the market
noise it generates.
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And traded by itself, this system is not reliable
in the long run.
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That’s why we have to smooth the indicator
by calculating it on a longer period.
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If in the previous strategy i preferred to
increase the sensitivity of the MFI, by reducing
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its value to 7, for this approach i prefer
to decrease its sensitivity.
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And I do this by setting a 50 period for the
indicator.
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We also keep the same filter for determining
the trend, namely the 200-period exponential
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moving average.
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Here is how it looks like.
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We added a 200-period exponential moving average
to estimate the market trend and 50-period
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money flow index, planning to take trades
when the indicators crosses its 50-centerline.but
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don’t take my settings for granted.
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Play with the periods of the MFI and even
the period of the EMA and back test yourself
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on different timeframes, to find the best
settings suited for your trading style.
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Here are a few trade examples of MFI centerline
crossovers.
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If you learned something new and found value,
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forget to subscribe and to hit the bell icon
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Until next time.
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