MFI indicator is a technical analysis tool commonly used in crypto investing. The MFI formula is similar to RSI but has some important improvements. In the following article, Crypto Trading will explain MFI and how to use this indicator.
Overview of MFI indicator
Money Flow Index or MFI indicator is a tool that measures the momentum of a financial asset. The measurement is done by showing the inflow and outflow of money into that asset over time.
What is the MFI indicator?
The MFI indicator analyzes price and volume. The MFI creates a limit oscillator that indicates when an asset may be overbought, oversold, or diverged from price. Is easy to read because the oscillator appears as a separate window at the bottom or top of the chart. The MFI can be used for any type of financial asset.
MFI is especially useful in crypto trading because the volume of trading activity factors into the oscillator’s calculations. We can use this volume on an intraday level. Long-time traders refer to MFI as a “volume-weighted RSI.” They see MFI as very similar to the Relative Strength Index (RSI) but with volume included.
MFI is a limited-value oscillator. The value of MFI is normalized from 0 to 100. The default setting is 14 periods and is usually viewed on the daily chart time frame. This is dictated by the fact that trading volume can vary depending on the time of day. Therefore, the daily time frame automatically incorporates fast and slow trading sessions.
How to calculate the MFI indicator?
The calculation of the MFI indicator is done as follows:
- MFI = 100 – [100 / (1 + MR)]
You can also calculate MFI as a percentage (%):
- MFI = 100 x [Positive Money Flow / (Positive Money Flow + Negative Money Flow)]
To calculate MR, you do the following:
Step 1: Determine the typical value of the asset (Typical Price – TP):
- TP = (Highest Price + Lowest Price + Closing Price) / 3
Step2: Calculate cash flow value (Money Flow – MF):
- MF = TP x Transaction volume during the calculation period
Step 3: Calculate MR:
- MR = Total positive cash flow (14 periods) / Total negative cash flow (14 periods)
Note: 14 periods is just an example. You can change to another period that interests you.
In there:
- Positive cash flow is defined as the sum of typical values in periods where typical values are higher than in previous periods.
- Negative cash flow is defined as the sum of typical values in periods where typical values are lower than in the previous period.
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How to use the MFI indicator for successful crypto trading
In the list of familiar indicators such as Stochastic Oscillator, Bollinger Bands indicator, MACD, RSI, etc., which indicators will MFI often combine with?
Combining RSI and MFI indicator
The MFI indicator and the RSI (Relative Strength Index) are closely related and have many similarities. First, both oscillators are limited to a range of 0 to 100. This means that the readings of both indicators cannot be less than 0 or greater than 100. Second, both the MFI and the RSI are momentum indicators that assess the strength of the underlying trend. When divergence occurs, it indicates that the underlying trend is weakening and about to reverse.
However, MFI and RSI are not the same. Traders should note two differences. First, MFI automatically calculates and uses “typical price,” while the RSI formula is based solely on the closing price of the candle. Traders can change the RSI parameters to include “typical price.” However, those parameters are not derived from the RSI formula. Second, trading volume is built into the MFI formula. The RSI formula is based entirely on price. Volume enthusiasts believe that MFI can predict trends and warn of potential reversals more promptly than RSI.
Combining Bollinger Bands and MFI indicator
The main purpose of combining MFI and Bollinger Bands is to determine the price trend. Traders can also identify overbought or oversold conditions of assets. Bollinger Bands are capable of determining the price range. Meanwhile, the task of MFI is to identify overbought and oversold conditions. When both tools give the same buy or sell signal, it proves that this is a strong signal. Traders can rely on it to make decisions.
Identify overbought/oversold zones using the MFI indicator
This trading method is simple and suitable for even new traders. It takes advantage of the overbought/oversold zone crossovers to trade with the trend. Specifically:
Enter buy order when MFI<20:
MFI falls below 20, signaling the market is oversold, with a potential uptrend. This is an opportunity for buying orders.
- Determining entry point: The MFI indicator crosses line 20, exiting the oversold zone. Or the price chart simultaneously shows a bullish candle, confirming the uptrend.
- Determine Stop Loss point: Set the stop loss level at the lowest level of the price chart.
- Determine take profit point: Ensure the profit/risk ratio (R: R) is greater than 1:2.
Enter sell order when MFI>80:
When MFI increases and exceeds 80, this is a warning signal that the market is overbought. The market may fall sharply, so traders should consider selling.
- Determining entry point: A potential sell signal appears when MFI crosses the 80 line (overbought zone). Or when the price chart appears as a bearish candle.
- Determine Stop Loss point: Set the stop loss point above the most recent peak of the uptrend.
- Determine take profit point: Ensure the profit/risk ratio (R: R) is greater than 1:2.
Note, that traders need to understand that overbought/oversold signals often appear. However, reversals do not always follow immediately. Traders should combine with other indicators to increase accuracy. In addition, after the price goes out of the overbought/oversold zone, you also need to monitor the movement of MFI to make more accurate decisions.
Identify Divergence with MFI
Divergence occurs when the crypto price moves in the opposite direction of the MFI. Bullish divergence is indicated when the price is falling but the MFI value is increasing. This shows that the selling pressure in the market is decreasing and buyers are ready. Bullish divergence is an opportunity to buy crypto at a cheaper price.
On the other hand, a bearish divergence occurs when the price of a crypto increases but the MFI value is lower. This signal shows that the buying pressure of the asset is decreasing in the market and sellers are ready. A bearish divergence presents a potential opportunity for sellers to cash out their holdings at a high price by placing a short sell order.
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What is the strategy to eliminate false signals in MFI indicator divergence?
Sometimes price reversal signals based on MFI divergence can be inaccurate. To filter out these noise signals, you can combine two strategies: “Failure Swings” and “Divergence”.
Bullish Failure Swing:
MFI drops below 20 (oversold zone), then recovers and breaks above 20. MFI continues to fall but does not reach the oversold zone (below 20). Finally, MFI breaks above the previous high, indicating weakening bearish momentum. This is a buy signal (bullish).
Bearish Failure Swing:
MFI rises above 80 (overbought zone), then falls below 80. MFI continues to rise but does not touch the overbought zone (above 80). Finally, MFI breaks above the previous low, indicating weakening momentum. This is a sell (bearish) signal.
summary
Hopefully, with the article about the MFI indicator, you have got the necessary information on how to use this indicator. Note that always be careful when analyzing techniques and think carefully before every decision. Don’t forget to follow the Crypto Trading blog to update your knowledge about coin trading.
FAQs
When did MFI first appear?
MFI originated from the Accumulation/Distribution Line method. The method was introduced by Marc Chaikin in the 1980s. Later, Gene Quong and Avrum Soudack further developed and used MFI to improve the measurement of overbought/oversold conditions.
In what cases does MFI often give false signals?
MFI can give false signals if the price does not move as predicted even though it has indicated a potential order execution point. For example, if there is a divergence signal but the price continues in the current trend instead of reversing.
How to use MFI more effectively?
To increase the effectiveness of using MFI, traders should note that they should not rely solely on overbought or oversold levels. Because the levels can change according to market conditions. You should combine MFI with other technical indicators to determine more accurate reversal points.
