Tips on Technicals - Money Flow
| Indicator type: |
Supply/Demand |
| Used to: |
Measure the flow of money in to or out of a market or instrument |
| Markets: |
All cash and futures, not options, but mainly in the stock market |
| Works Best: |
Daily and weekly stocks, stock sectors and stock markets. The tick time frame is also useful. Only liquid markets yield valid analysis. |
| Formula: |
(Price times volume on upticks) minus (price times volume on downticks). Zero ticks are ignored. |
| Parameters: |
Total, block and non-block. Non-block money flow excludes the value, but not direction, of block trades of 10,000 shares or more. Block money flow only includes the value of block trades. |
| Theory: |
A rising market should have more and larger trades taking place on upticks than on downticks. Conversely, a falling market should have more and larger trades taking place on downticks. Flat markets should have similar uptick and downtick activity.
If a rising market starts to have more downtick activity then distribution is occurring and supply is becoming greater than demand. This is a bearish warning. Conversely, accumulation and rising demand result in rising money flow.
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| Interpretation: |
Since money flow charts show price and money flow tracking each other (no divergence) about 80% of the time, tradable signals occur infrequently. Just like with divergences between price and other indicators, money flow divergence is usually resolved by price correcting to money flow. However, since the money flow overlay on a price chart is relative, different spans have different looks. Potential divergences must be verified in several time frames.
In order for a money flow divergence to be valid, price and money flow should track each other for at least half of the time frame used. For example, if a 250 day daily chart is used, the two lines should track each other for at least 125 days before they diverge. Charts showing an "X" pattern where they do not track each other at all do not show any meaningful divergences.
Non-block money flow excludes large trades that could skew the analysis. Both non-block and total money flows should be analyzed.
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When a stock is trending higher, money flow should be trending higher. Money flow would be behaving as expected. In Figure 1, money flow (line) was rising along with the price (bars) of Eastman Kodak.
Figure 2 shows that price for Johnson and Johnson was falling while money flow was rising. This bullish divergence was resolved in Figure 3 as price moved higher.
A money flow signal should not be the only reason to trade. Rather, it is most useful as a trade supporting indicator or opportunity identifying tool. For the former, money flow may provide the added confirmation needed when trend line and oscillator analyses are questionable. For the latter, a divergence seen between price and money flow should lead to a full analysis of the stock or commodity. This is especially useful to money managers keeping track of large numbers of instruments.
