How to Profit in Forex with the Money Flow Index Indicator

The money flow index indicator is an advanced technical indicator available free of charge within most Forex trading platforms. It is plotted directly on a price chart for an easy-to-read visual representation of momentum. Trading with strong market momentum can be the basis of a profitable Forex trading strategy. I have taken a closer look at the money flow index indicator in this article to help you decide whether to use this indicator in your trading as you work towards becoming a more profitable Forex trader.

What is the Money Flow Index Indicator?

The money flow index indicator (MFI) is an oscillator and momentum indicator which produces a single numerical output between 0 and 100. The maximum bullish (upwards) momentum value is represented by 100 while the maximum bearish (downwards) momentum value is represented by 0.

The MFI is often described as a volume-weighted version of the Relative Strength Index. The exact calculation of the MFI will be outlined later in this article. It uses a combination of price and volume, two of the most definite elements of technical analysis, to determine the strength of momentum at any given time. Forex traders typically use the MFI to identify positive and negative divergences between the indicator value and the price action, or to fade (trade a reversal) overbought (above 80) or oversold (below 20) levels.

However, buying or selling based solely on the value of an indicator applied to a single time frame in Forex is a money flow index strategy that I do not recommend, as it is never profitable in the long term. The MFI is best used in more sophisticated ways which I will talk about later in this article.

Since the MFI uses volume and the Forex market is decentralized, accurate volume data is not typically easily available. This makes using the MFI more challenging for Forex traders than equity traders, who have clear volume data available. Some Forex brokers have begun to provide real-time volume data, but such data incorporate only the broker’s internal flow or volume data from their liquidity providers, which does not reflect the entire market. Some Forex traders try to work around this problem by using tick data, on the basis that studies have identified a reliable correlation between tick data and overall market volume.

Note that money flow index indicators built into or added as plugins to the MetaTrader 4 or MetaTrader 5 trading platforms use tick volume to calculate the volume element. As there are a few Forex brokers offering their own volume data, it is possible to find some versions of the MFI indicator which use the broker’s volume data, although they can be difficult to find. There is a third option which is not discussed enough: volume data is available for currency pair futures which are traded over the counter on major U.S. exchanges. This offers the possibility to plug the MFI indicator into currency futures data, while trading the spot Forex equivalent from the MFI indicator data generated by the equivalent currency future. This can work well if you can set it up, although futures are only available on a limited number of currency pairs, mostly the majors.

How to Use the Money Flow Index Indicator (MFI)

I will start by discussing the three types of trading signals the MFI can generate. Before using any technical indicator, I always stress the importance of understanding what indicators can tell traders about price action. Many new traders rush into using indicators without knowing how to apply them effectively. They rely on the simplest principles, which I want to note again, do not generate consistent profits. Otherwise, the retail loss rate of Forex traders would not range between 70% and 85% at most major Forex brokerages.

Here are the three types of trading signals that MFI provides:

1. Oversold and Overbought Levels: When the MFI moves below 20, traders consider the asset oversold. An overbought condition occurs with the MFI above 80. They are the most direct trading signals from the MFI but also the least reliable. Shorter time frames, for example, the M5 or M15 charts, will get more readings below 20 and above 80. The drawback remains reduced reliability. I prefer the MFI on the H1 chart, a middle ground between frequency and accuracy. Some traders wait for the MFI to break out or break down above and below 20 and 80 before entering a trend, as it may suggest the correction or sell-off is near the end, with volume flowing into the asset for a trend reversal.

Here are three examples of the MFI providing traders with oversold or overbought trading signals.

MFI Indicator Showing Positive Divergence

2. Positive and Negative Divergences: I prefer trading divergences, as they provide the most reliable trading signals in my opinion. A positive divergence appears when price action records a lower low, while the MFI, or any other indicator, sets a higher low. A negative divergence forms when price action records a higher high while the indicator sets a lower high. Positive and negative divergences receive their confirmations from failure swings, the third trading signal from the MFI.

3. Bullish and Bearish Failure Swings: While positive and negative divergences remain excellent trading signals, I recommend confirming them with bullish and bearish failure swings. You will lose out on some of the price action, but the reliability increases notably. A bullish failure swing materializes when the MFI moves below 20, then reverses above it, corrects from its peak but remains above 20, and then accelerates to a higher high. A bearish failure swing occurs after the MFI pushes above 80, drops below it before advancing but maintaining its position below 80 before plunging to a lower low.

Below is an example of a negative divergence confirmed by a bearish failure swing, followed by a sell-off in price action.

MFI Indicator Showing Negative Divergence

Here are my recommendations for using the money flow index indicator:

1. I prefer using the MFI on the H1 chart, while taking direction from a higher time frame chart such as the daily (D1) or weekly (W1) time frame, as it provides me with an ideal balance of trading signal frequency and reliability. You can use shorter time frames, which increases the frequency at the expense of reliability. You will get many false signals, and I do not recommend it. It is better to focus on quality trading signals rather than the quantity of them. Traders may use higher time frames to increase reliability. The drawback is low frequency, keeping you sidelined for prolonged periods. In my opinion, the profits you miss being out of the market remain as significant as trading losses.

2. I recommend trading only the most liquid currency pairs for any money flow index strategy because there is more balanced price action. In less liquid currency pairs, lower volume trades may spike or plunge an asset, which can generate false signals. Another added benefit is the lower spread usually available on such currency pairs. As an active trader, I also benefit from volume-based rebate programs, ensuring each trade earns me more cash per pip. Trading costs can make a significant difference over the long run.

3. Be careful when using the 20 and the 80 levels on the MFI for identifying oversold and overbought conditions. I find them very unreliable and do not trade from such an overly simplistic strategy. Instead, I use these oversold / overbought signals as an early indicator that a trend reversal may follow. Once the MFI moves below or above 20 and 80, I monitor the charts for a positive or negative divergence. They are relatively infrequent, but mostly reliable if confirmed by bullish and bearish failure swings.

4. Confirm buy and sell signals from at least one other source. Avoid using identical ones. For example, using the MFI and the RSI together does not make sense, as the indicators are so similar. Use other aspects of technical analysis to decrease the downside risk of your trades. I never take a position without confirming it from two (or ideally three) different sources. Consider support and resistance levels, together with the existing trend, which I determine from the daily or weekly time frame chart.

5. Using the MFI and any other aspect of technical analysis is an art form and not science. Therefore, I recommend studying how the MFI works with each asset you want to trade rather than commit to certain levels. It requires time and patience, but the experience you gain is priceless and will make you a better trader over time.

Here is an example of the MFI staying clear of the 20 and 80 levels but producing reliable trading signals.

Using MFI Indicator Without Overbought / Oversold

6. I caution against MFI-driven Expert Advisors (EAs) because of the complexity of positive and negative divergences as well as bullish and bearish failure swings. Algorithmic MFI trading solutions exit. Regrettably, they are not available in MQL4 or MQL5, the language used to create EAs in MT4 and MT5.

EAs generally enter trades based on the 20 and 80 levels, resulting in many trading losses. Below is an example of a bad trade signal this strategy typically generates:

MFI Indicator Showing Failed Oversold Signal

How to Apply the Money Flow Index Indicator (MFI) in MT4/MT5

Since the MFI is a widely used oscillator, it is available in the out-of-the-box MT4 and MT5 trading platforms.

Here is how to apply the MFI in MT4:

1. Open your MT4 trading terminal.

2. Click on Insert in the top menu bar and then on Indicators.

3. Navigate to Volumes, and then select Money Flow Index.

Here is how to apply the MFI in MT5:

4. Open your MT4 trading terminal.

5. Click on Insert in the top menu bar and then on Indicators.

6. Navigate to Customs, and then select MFI.

The default settings for oversold and overbought conditions are 20 and 80, but traders can adjust them to their liking.

Applying the MFI Indicator to MT5 Price Chart

Some traders prefer using the 10 and 90 levels to signify oversold / overbought to reduce false early signals. I use the 20 and 80 levels, as they offer more flexibility for positive and negative divergences and bullish and bearish failure swings.

How to Calculate the Money Flow Index Indicator (MFI)

The MT4 and MT5 trading platforms calculate the money flow index indicator automatically. Despite this, I always recommend traders understand how the calculations work, enhancing the understanding of what the MFI shows. Traders who understand how to plot the MFI manually, including the computations, will increase their success rate when using it.

Here is the math to calculate the MFI, and I will explain each step below.

Money FIow Index Calculation Formula

1. Calculate the typical price by adding the high, low, and close. Then divide it by three.

2. Calculate the money flow by multiplying the typical price by volume. If the current price is above the previous one, it is known as positive money flow. If the current price is below the previous one, it is known as negative money flow.

3. Calculate the money flow ratio by dividing the 14-period positive money flow by the 14-period negative money flow. Positive money flow is the sum of positive money over the past fourteen days, and negative money flow is the sum of negative money.

4. Calculate the money flow index indicator using the formula: 100 - 100/ (1 + money flow ratio).

Final Thoughts

The MFI can offer reliable trading signals, but traders should not consider it a holy grail. I recommend using positive and negative divergence signals as the best method to generate trade entry ideas, confirmed by bullish and bearish failure swings. I also advise using the MFI in conjunction with at least one other indicator and one other time frame, with the lower time frame no lower than the hourly (H1).

FAQs

How do you interpret the money flow index?

The MFI is a technical oscillator and momentum indicator like the Relative Strength Index, but its calculation also involves trading volume.

What is the best money flow indicator?

The standard one available for free within the MT4 and MT5 trading platforms will suit most traders just fine.

Which is better: RSI or MFI?

Neither is obviously better. Both can deliver accurate trading signals but tend to work better at different times. When volume is more decisive in a market, the MFI is likely to work better.

Is MFI a leading indicator?

Yes, the MFI is a leading indicator.