Among the various momentum FX indicators that you get in MetaTrader 4, the MFI or Money Flow Index is one popular one. It is used to predict the reliability of the current trend in a market, by utilising an instrument's volume and price. It is also referred to as volume-weighted RSI since the MFI adds trading volume to the Relative Strength Index.
There are several steps you have to follow to get the index figure. Professionals normally advise traders to use 14 days for the basis of their calculations.
- First, you have to define the typical price. This can be done by (High+Low+Close) / 3
- Secondly, calculate the Raw money Flow as Volume* Typical price.
- Lastly, you need to find out the Money flow Ratio. To do this divide the 14-period positive money flow with the 14-period negative money flow.
Here positive money refers to positive values of money, typically created when the typical price is greater than the typical price value from before. In other words, positive money flow is the sum of positive money over the number of periods(in this case 14 days).
So to get the Money Flow Index, perform the following formula: 100-[100/(Money Flow Ratio+1)]. The majority of expert traders wait for the moment in which the Money Flow Index moves in the opposite direction of the price. The divergence can indicate a change in the current trend of the market.
Where will you find MFI in the MT4 Terminal?
After opening the MetaTrader 4, go to indicators > Bill Williams to find the MFI indicator. It is displayed in a separate window which you can find under the price chart. It has the appearance of a histogram consisting of 4 different colours. The default colours are listed below, although you can customise the colour and width of the bars.
- Lime- MFI upwards, volume up
- Blue- MFI upwards, volume down
- SaddleBrown- MFI downwards, volume down
- Pink- MFI downwards, volume up
The MFI doesn’t use the highs and lows normally in trading and it is up to you whether you would like to use them.
Reading the MFI Indicator: What does it tell us?
The colour-coded bars in the MFI indicator provide us with the following information.
- The Lime bar represents an increase in the number of market operations and indicates that the trend is getting stronger. As new players enter the market and start making a lot of operations, the current impulse may continue. As the impulse emerged much earlier and the price has already covered a long distance, do not use this signal for opening positions. However, if you already have an open position, the growth of the lime bar will confirm your position.
- The Blue Bar indicates that the impulse is currently developing. This is due to buyers and sellers leaving the market after losing interest, rather than new players entering the market.
- The Pink Bar indicates that bulls and bears are both active. It is a promise of a reversal and hence is most preferable for traders.
- The SaddleBrown bar indicates that liquidity and volatility are on the decline as market participants are losing interest. The probability of a future reversal is nil in this case. This bar normally comes before a “flat”, after which the price may proceed in either direction with equal probability.
How to use the Money Flow Index in Trading?
The MFI can easily be used for trading in the MetaTrader 4 terminal. However, experts advise against not using this indicator alone and instead combine it with other indicators when making trading decisions. Here are some of the ways you can use MFI.
- Identifying overbought and oversold levels: Similar to the Relative Strength Index, The MFI can also be used to identify overbought and oversold levels. The MFI is oversold when it goes below 20 and overbought when it goes above 80. It is however not a guarantee that a reversal will occur when overbought and oversold levels are reached. The price may go higher than 80 or lower than 20, especially when it is an exceptionally strong trend.
- To find Divergence: The points at where an asset’s price is rising while the indicator is falling, or vice versa, is known as divergences. You can spot a divergent period early on to find out whether a reversal is about to happen. The first step involves looking at an asset’s price visually to see the initial trend. Join the key levels after looking at the performance of the MFI. If the price is rising with the MFI moving lower, it’s a sign that a bearish trend is upcoming.
- For Day trading: MFI is also an indicator you can use to find out and eliminate wrong signals. In other words, the indicator can decline when the price is rising, particularly when there are a lot of divergences. Day traders can avoid these situations by combining several technical indicators like RSI and Fibonacci, along with MFI.
Relationship with Relative Strength Index
Both the Relative Strength Index and Money Flow Index are closely related, with the only difference being the incorporation of volume. Thus, traders who prefer volume analysis consider it to be a leading indicator. The MFI provides warning signs and signals of possible reversals to traders in a more timely manner compared to the RSI. This is not to say that one indicator is better than the other. Rather it shows that the indicators incorporate different elements and thus produce signals at different times.
Conclusion
The MFI or Money Flow Index can be a useful indicator for traders using MT4. However, no indicator is fail-proof and MFI is no exception. There may be instances where it may fail to warn you of something important. For instance, a divergence might result in price reversing some of the time. However, divergence won't be present in all price reversals. This is one of the reasons why you shouldn’t rely on the MFI indicator alone but combine it with other forms of risk control and analysis.