Money Flow Indicator
Most serious investors in the stock market make an analysis of the behavior of their selected stocks over a given period or session, on which to base their decisions on the entry and exit points for their trading activity. The Money Flow Indicator is one such aid used by investors to understand stock price movements. The concept was developed by Marc Chaikin, who studied both price and volume in tandem so as to gain a better perspective of the stock price mechanism.
What is the Money Flow Indicator?
The Money Flow Indicator is best understood by the concepts of accumulation and distribution. Chaikinâ€™s observation was that if a stock closed above its midpoint during a given session, the stock was in a phase of â€˜accumulationâ€™ for that day. On the other hand, if the stock closed below its midpoint, he referred to it as a phase of distribution. In making this analysis, he assembled the data for the price movements in a given session in the form of bars. The midpoint of an issue is the highest trade of the day added to the lowest trade of the day divided by 2. Chaikin used price and volume together to arrive at his conclusions. Over a 21-day â€˜sessionâ€™ or trading period, he added the accumulation/distribution number for 21 days and then divided this number by the sum of the volume for the same 21-day period. The Chaikin Money Flow (CMF) index value increases when the stock closes near the high of the session with volume increase, and decreases when the stock closes near the low of the session with volume increase.
Using CMF as a trading tool
The Chaikin Money Flow oscillator is thus a useful tool that helps identify the trading trends for a given stock. It not only indicates whether a stock is in the accumulation (bullish) phase, but also serves to indicate the strength of the accumulation.
Zero Line Crosses: If the CMF index has been positive (above zero) for the most part of the preceding three months, then it signals a buying pressure. The same holds good for the converse. The stock is bullish as long as the CMF indicator is above 0, while a reading below 0 indicates a bearish sign for the stock.
Trend Lines: The duration of the reading, or the length of time the oscillator has been positive is another important feature. If there has been sustained accumulation, market sentiment towards the stock remains positive and bullish. The intensity of the oscillator is a key trend indicator. The more positive the reading is, the higher is the buying pressure and accumulation. Traders use these trend lines on the indicators to spot breakouts, and track price movements on the chart. The success of this approach hinges on making accurate estimations of the trend on the indicator.
Divergence: When the CMF indicator makes a higher high, while the price action makes a lower low, there is a resultant divergence. It implies that there is lowered selling pressure which is pushing the stock lower, indicating a bounce.
CHAIKIN MONEY FLOW CHARTING EXAMPLE
Cons: Although money flow can be an exceptional tool for assessing overbought and oversold positions, its reliance on accumulation/distribution may result in some distortion in the absence of a clearly defined midpoint. It is advised that the CMF should not be used as an exclusive indicator, but should be used in consonance with other technical indicators.
Pros: The use of both price and volume provides a different perspective from price or volume alone. The money flow indicator tends to show dramatic oscillations and can be useful in identifying overbought and oversold conditions."
Marc Chaikin, Senior Vice president of Instinet Corp., started his financial career in 1966 at Shearson Hammill, and got his license as a stockbroker on the very day the bear market of 1966 ended.
For the first two and a half years of his career, Chaikin noted that the trade experienced a good run of upticks, and he benefited from Shearson's well reputed research department. By following their recommendations, he made sizeable profits for clients. Two years down the line, he commenced his own technical analysis which took the shape of the Chaikin Money Flow Indicator. He built his concept based on the pioneering work done by Joe Granville and Larry Williams.
Books: Chaikin's Money Flow by Christopher Narcouzi,