Money flow is a term from finance that describes a measurement used to evaluate the status of an asset. It approximates the daily trading volume of the asset in dollars. Finding the money flow is the basis for determining if a stock is overbought or oversold. It is not a perfect predictor of misvaluations of assets, but it does give investors an idea of the direction in which an error might lie. They can take advantage of these errors in pricing to make strategic investments so they can profit when the price of the asset reverts to its actual value.
To calculate money flow, gather the closing price, the high price for the day and the low price for the day. Average these three prices together. Multiply the resulting figure by the daily volume of the asset — that is, the number of shares traded during the day. This figure is the money flow, also known as “raw money flow.” This means little on its own since each asset will have a different measurement.
Investors do not want to compare between assets; rather, they are interested in the market’s trading behavior for one asset over time. Investors compare the money flow to the same measurement from the previous day so they can describe it as positive or negative. These qualifications describe the relative prices at which an asset was sold.
Positive and negative money flows have meaning within a day of trading, as well. An asset bought on the uptick is bought when the price rises, and an asset bought on the downtick is bought when the price falls. The positive money flow is the raw flow for periods in which more assets were bought on the uptick than the downtick: periods in which the average of the three prices increased. The negative flow is the same measurement, but it is taken over periods in which more assets were bought on the downtick. The positive flow divided by the negative flow over some period gives the money ratio for that period.
The money flow index, or MFI, is derived from the money ratio. The MFI is equal to 100 – 100/(1 + Money Ratio). If the MFI is higher than 80, then the asset is probably overbought, and if the MFI is under 20, then it is thought to be oversold. Also, movement of the stock price in the opposite direction from the money flow signals investors that there may be an opportunity for profit.
