Money Flow Index (MFI): An Essential Indicator for Algo Trading

If you are an algo trader or investor looking for an essential indicator to include in your tool kit, the Money Flow Index (MFI) is definitely one to consider. Developed by Gene Quong and Avrum Soudack, the MFI is a momentum indicator that uses both price and volume data to analyze buying and selling pressure.

How Does the MFI Work?

The MFI looks at the divergence between closing prices and trading volume to make its calculations. Specifically, it takes into account the volume of trades that occur on days when prices rise versus days when prices fall. The calculation then produces a ratio that ranges from 0 to 100, which can demonstrate whether buying or selling pressure is occurring.

When the MFI is above 80, it indicates that buying pressure is strong, and prices may be overbought. Conversely, an MFI below 20 shows that selling pressure is strong, and prices may be oversold. When the MFI hovers around the 50 mark, it indicates balance, and there is no clear trend in either direction.

How Can Algo Traders Use the MFI?

There are various ways that algo traders can use the MFI to inform their investment strategies. Here are a few examples:

Confirming Market Trends

The MFI can help confirm market trends by indicating whether buying or selling pressure is increasing or decreasing. Multiple consecutive readings above or below the 50 mark may indicate a persistent trend in the making.

Finding Overbought and Oversold Conditions

Algo traders can also use the MFI to identify overbought and oversold market conditions. If the MFI is above 80, it's an indication that the buying pressure has been strong, and it could soon drop as is reflected by a Bearish Divergence. A move below the 20 mark indicates the reverse with High Selling Pressure pushing the market into a Bullish Divergence.

Using the MFI with Other Indicators

Algo traders can also use the MFI in combination with other technical indicators to increase the accuracy of their signals. For example, by using the MFI with the Relative Strength Index (RSI) which is a known oscillator, traders can identify situations where RSI is peaking but MFI is not, giving rise to divergence signals.

Conclusion

The Money Flow Index is a highly useful indicator for any algo trader or investor. By analyzing both price and volume data, the MFI provides a more complete picture of market trends, as well as when buying and selling pressure is strong. When used in conjunction with other technical indicators, the MFI can be a powerful tool in increasing the accuracy of trading signals.