Money Flow Index: How to Use It to Trade Bitcoin
Key Questions Answered
- The Money Flow Index, or MFI is used to signal when BTC is overbought or oversold.
- the Money Flow Index oscillates between 0-100. Overbought conditions are signaled when the indicator reaches 90, while oversold conditions are signaled when the indicator reaches 10.
- If the MFI indicator is trending in the same direction as the price of BTC, there is no divergence present. However, if the MFI indicator is trending in the opposite direction as the price of BTC, there is either a bearish or a bullish divergence at play.
What is the Money Flow Index?
The Money Flow Index, or MFI, is an important (but lesser-known) oscillator that may be used when conducting technical analysis on the price of Bitcoin or other cryptocurrencies. In general, the tool may be used to signal when BTC is overbought or oversold.
As is the case with other oscillators — such as the more-common Relative Strength Index, or RSI — the Money Flow Index oscillates between a minimum of 0 and a maximum of 100. Overbought conditions are generally signaled when the indicator reaches 90, while oversold conditions are signaled when the indicator reaches 10.
The Money Flow Index (MFI) primarily uses both price and volume to indicate when a buy or sell opportunity may be present. It is often used to spot divergences, and — like all indicators — it is most optimally used in conjunction with other indicators in a well-defined and personalized trading strategy.
A chart of the price of BTC with the MFI indicator underneath, on the four-hour time frame, with exclamation points indicating overbought and oversold conditions. Source: TradingView
How is the Money Flow Index calculated?
When seeking to understand the Money Flow Index, it is critical to understand exactly how it works — even if you have no interest in running the calculations yourself.
First and foremost, technical analysts define a time period, and the typical price during the said period, with the following formula:
TP = (High + Low + Close) / 3
In this formula, High is the highest price of BTC. Likewise, Low is the lowest price of BTC and Close is the closing price of BTC during the time period.
Next, Money Flow must be defined in this way:
MF = TP * Volume
This allows us to see if the Money Flow for our defined time frame is positive or negative.
After that, we must find the Money Ratio by dividing the positive money flow by the negative money flow using the following formula:
MR = Positive MF / Negative MF
Finally, we may calculate the Money Flow Index as such:
MFI = 100 – (100/ (1+MR))
With these calculations, the Money Flow Index may be used to identify overbought or oversold conditions, as well as bearish or bullish divergences.
How to Use The Money Flow Index to Find Divergence?
Divergences are one of the most powerful indications of a potential trend reversal that the Money Flow Index offers.
Divergences are simple. If the MFI indicator is trending in the same direction as the price of BTC, there is no divergence present. However, if the MFI indicator is trending in the opposite direction as the price of BTC, there is either a bearish or a bullish divergence at play:
- Bearish divergence: if the price of BTC is pushing higher as the MFI indicator is moving downward, there is a bearish divergence signaling that the price of BTC may soon correct downwards.
- Bullish divergence: if the MFI starts moving upwards while BTC is selling off, there is a bullish divergence which may indicate that the price of BTC may soon bounce and push higher.
As such, bearish and bullish divergences on the MFI work essentially the same way as they do on other indicators, such as the RSI.
price of BTC with the MFI indicator with one instance each of a potential bearish and bullish divergence. Source: TradingView
As illustrated above, divergences are never guaranteed to play out as expected and do not universally signal that a change in Bitcoin’s price trend will happen. More so than other assets, BTC and cryptocurrencies really like to march to the beats of their own drums and are not beholden to signals from oscillating indicators.
Likewise, simply trading off of overbought or oversold conditions is not guaranteed to be the most profitable strategy, either. Bitcoin and other assets may remain overbought or oversold for long periods of time — especially when the market is being driven by a lot of hype or a shift in fundamentals.
A Bitcoin price chart on the weekly timeframe indicating prologued periods of overbought price action. Source: TradingView
The Money Flow Index indicator is an oscillating technical indicator that may be used to identify overbought or oversold market conditions, as well as bearish or bullish divergences.
When used in combination with other technical indicators and a well-defined trading strategy, the Money Flow Index may prove to be a useful tool when buying and selling Bitcoin or other cryptocurrencies on spot markets or in leveraged trades.
No single technical indicator is perfect. As such, the MFI should not be relied on, in isolation, to provide perfect signals for timing tops and bottoms of markets. It is, perhaps, best used in conjunction with the Moving Average Convergence Divergence (MACD) and/or the Relative Strength Index (RSI).