Technical Analysis: The Importance of Money Flow

When it comes to trading, one of the best ways to tell what’s happening is by paying attention to the flow of money in and out of a stock. None of us want to buy a stock if money is flowing out, right? Of course not… It’s a great way to lose money.  Instead, we want to buy if we’re seeing money flow in.

It’s why we pay close attention to the Money Flow Index (MFI) – an essential, popular indicator that indicates the strength of money flowing in or out. Money flow is considered positive when prices rise, and negative on price declines with selling pressure.

It’s also helpful when confirming price trends, producing signals of potential reversals from overbought and oversold conditions.  If MFI is below 20, the stock is considered oversold. If MFI is above 80, the stock is considered overbought.

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About 80% of the time, when Money Flow dips well into oversold territory with a well-respected stock, it’s likely to bounce higher.

Notice what happened on this two-year chart of Bristol Myers Squibb (BMY).

After falling in recent months on news of a drug failure, the stock became excessively oversold with regards to money flow indicators.  That’s pretty negative.  But it also tells us money flow can only go up from here.  It can’t go much further south.

Historically, when Money Flow falls to 20 or less on BMY, it marks the bottom of trend.  That wasn’t the case in August 2016, but then again, we’re not talking about a perfect indication of market bottoms.

On a move in MFI above 20 in August 2015 and again in February 2017, Money Flow was spot on, and called the bottom of trend.  Of course, it’s always best if Money Flow is only used to confirm other momentum indicators.

As with all technical indicators, MFI should not be solely used.  It should be used to confirm other indicators, such as MACD, RSI, Bollinger Bands and Williams % Range, for example.

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