The Money Flow Index (MFI) is a technical indicator that can help binary options traders to easily find profitable trading opportunities. The MFI is a popular indicator because even newcomers can quickly use it to make quality decisions.
In this article, you will learn:
- What is the Money Flow Index (MFI)?
- How to interpret the Money Flow Index (MFI)
- How to trade the Money Flow Index (MFI) with binary options
With this information, you will immediately be able to use the MFI for your binary options trading.
What Is The Money Flow Index (MFI)?
The Money Flow Index has a simple purpose: it indicates how traders currently feel about an asset. Traders can use this information to predict how this sentiment will affect future price movements.
To make this prediction as simple as possible, the MFI offers traders a clear reading that oscillates between 0 and 100. This reading, its change over time, and its relation to the asset’s price movements are all you need to make a simple trading prediction.
The MFI calculates its value in four steps:
- Typical price for each period: The MFI calculates each period’s typical price as the average of the period’s high, low, and close prices.
- Money flow: The MFI multiplies each period’s typical price with its volume.
- Money ratio: The MFI adds up the money flow of all periods with rising prices and divides them by the added money flow of all periods with falling prices.
- Final MFI: To make comparing the MFI’s reading easier, the indicator divides 100 by 1 plus the money ration. The result is the final MFI.
Understanding the final MFI is simple:
- A value of 100 indicates that all money has been flowing into an asset – every period had rising prices.
- A value of 0 indicates that all money has been flowing out of an asset – every period had falling prices.
- A value of 50 indicates that just as much money has been flowing out of an asset as into it.
- A value of 66 indicates that twice as much money has been flowing into an asset as out of it.
- A value of 33 indicates that twice as much money has been flowing out of asset as into it.
In short, the higher the MFI’s value, the more money has been flowing into it. The lower the MFI’s value, the less money has been flowing into it.
How To ReadThe Money Flow Index (MFI)
The MFI works best during a trend. When an asset is in a trend, the MFI can help you to decide whether you should still invest in the continuation of the trend or in an impending turnaround. There are three ways in which traders interpret the MFI:
Indication 1: General direction
The first thing you can learn from the MFI is its general direction.
- When the MFI is moving upwards, money is flowing into the asset.
- When the MFI is moving downwards, money is flowing out of the asset.
You can use this knowledge to predict that the asset will react accordingly:
- When money is flowing into an asset, demand outweighs supply. The asset’s price will rise.
- When money is flowing out of an asset, supply outweighs demand. The asset’s price will fall.
Without the use of additional indicators, this is a short-term prediction. While it is true that an asset’s price will rise or fall when money is flowing in or out, respectively, the MFI’s direction alone provides you with no indication of how long this movement will last.
Indication 2: Overbought and oversold areas
A less risky, more common way of interpreting the MFI is trading its oversold and overbought areas. The logic behind this strategy is simple: since the MFI’s value oscillates between 0 and 100, the market has to be in a special situation when it nears either extreme. Such special situations provide profitable opportunities for an investment.
- When the MFI reaches a value of over 80, the asset is considered overbought.
- When the MFI reaches a value of below 20, the asset is considered oversold.
Based on these indications, traders predict that the market will now turn around:
- When the MFI reaches a value of over 80, the asset has moved upwards for some time. The MFI’s high value predicts that this movement will end soon and that the market will turn around.
- When the MFI reaches a value of below 20, the asset has moved downwards for some time. The MFI’s low value predicts that this movement will end soon and that the market will turn around.
To understand this prediction, consider that an asset’s price is solely determined by the relationship of supply and demand. Even if a company is doing well, its stock can only rise when demand outweighs demand. In this case, that might happen regularly, but it is impossible to happen always. There will be many situations in which all traders who can and want to buy the asset have bought it, and the sellers outnumber the buyers – the market has to fall, even if the asset is perfect. The same applies to situations where everyone who is willing and able to sell has sold – the price of the asset must rise.
The MFI helps you to identify these situations and profit from them.
Some traders also define different values for the overbought and oversold areas. They might only invest in falling prices when the market has moved above 90 or below 10 or even 95 and 5.
Indication 3: Divergence
The MFI’s most significant but rarest signal is a divergence from the price movement. When an asset is trending upwards, for example, it is in a zig-zag movement in a general upwards direction. It takes two steps upwards and one step down, while it climbs to continually higher highs and lows.
In an intact trend, the MFI mirrors this movement. When the market reaches a new high, the MFI is higher than at the market’s previous high. In an intact downtrend, the MFI mirrors the market, too: when the market reaches a new low, the MFI reaches a new low, too.
As soon as the MFI fails to mirror the market – as soon as it diverges from it – the trend is in trouble. While the market still managed to create a new extreme point, the sentiment has already begun to shift.
- If the market was in an uptrend, traders have lost faith in this trend. This is why less money has flown into the asset, and the MFI has failed to reach a new high.
- If the market was in an uptrend, traders are beginning to buy again. This is why less money has flown out of the asset, and the MFI has failed to reach a new low.
In both cases, the trend is doomed. It will likely turn around or at least go through an extended consolidation period.
How To Trade The Money Flow Index (MFI)
You can trade each of the MFI’s indications individually or combine them to a grand strategy. Let’s look at each possibility individually.
Trading the MFI’s direction
This is the simplest and riskiest strategy, but also the strategy with the highest potential. All you have to do is invest in the MFI’s direction:
- When the MFI is moving upwards, invest in a high option.
- When the MFI is moving downwards, invest in a low option.
This type of strategy is so easy that even complete newcomers can execute it. It can also make you a lot of money. Since the MFI is always moving up or down, you can invest at any time and make a lot of trades. If you win a lot of trades, you can also make a lot of money. Since the MFI’s direction alone is a very short-term prediction, it is best to play it safe and choose an expiry no longer than one period.
You can also combine the MFI with other indicators. These indicators filter signals, which means that you will create fewer signals but can win more trades. You are trading potential for security, which can be a smart move. For example, some traders combine the MFI with a moving average. They only invest when the MFI and the moving average are pointing in the same direction.
Some traders also wait for special events before they invest in the MFI’s direction. For example, some traders invest when the direction turns around, for example investing in a low option when the direction changes from upwards to downwards. These traders hope to increase their chances by investing right at the start of the movement but also risk to invest on a twitch that means nothings. Try those tactics with a demo account and decide for yourself whether you want to use them.
Trading the MFI’s overbought and oversold areas
This strategy is less risky but will also fewer signals. When the MFI reaches and overbought or oversold area, you invest in the opposite direction of the preceding movement.
- When the MFI reaches the overbought area, you invest in a low option.
- When the MFI reaches the oversold are, you invest in a high option.
The problem with this strategy is that long trends sometimes keep the MFI in an extreme area for a long time. On short time frames, as you use them with binary options, this risk is limited, which is why you can decide to live with it. You should be able to make money anyway. Make sure to choose a medium to long expiry to give the market enough time to turn around. Using a demo account can help you find the right timing.
Alternatively, you can also vary your strategy to sure things up a little:
- Some traders only invest when the MFI leaves an extreme area. Now the market has turned around. The problem with this strategy is that you enter the movement at a later time, which is why it is now shorter and your timing must be more accurate. Shorten your expiry and use a demo account until you know that you can time your investment well.
- Some traders narrow down the MFI’s extreme area. Depending on your preference, you might only invest when the MFI reaches a value of over 90 and below 10 or over 95 and below 5. A narrower extreme value creates more reliable but rarer signals. This trade-off can be worth it, but you should avoid overdoing it. It is better to win 8 of 10 trades than 2 of 2. Play around with your ideal value a little, and you will soon find the ideal setting for your personality.
Trading MFI divergences
This is the safest strategy, but also the strategy that will rarely create a signal. When the MFI diverges from the market, you can be sure that the current trend is in trouble. The turnaround might take some time to develop, but as long as you trade it with a long expiry, you should be able to win a high percentage of your trades.
Unfortunately, divergences are rare. First you have to find a solid trend, then you have to wait until the MFI diverges from it. Additionally, not all trends diverge, and you might have wasted your time. To balance this rareness of signals, you can invest a little more per trade, up to 5 percent of your overall account balance. As long as you know what you are doing with your expiry, you should win enough trades to justify such a high investment.
Combining the strategies
Finally, you can combine these strategies. There are several ways in which you can do this:
- Creating more signals. When you trade multiple of the MFI’s indications, you can create more signals and make more money. For example, traders of MFI divergences should always add trading the MFI’s extreme areas, at least in a narrowed down version. They have to monitor a long trend anyway, so they might as well invest when then MFI moves above 90 or below 10 and take the easy money. Other strategies offer similar possibilities. Try to find the one that fits your personal approach.
- Trading more accurately. When the MFI diverges off the market, you can use the overbought and oversold areas to find the perfect time to invest. You already know that the current movement must end, so you can search for a different time frame and monitor the MFI’s extremes. Once the market reaches an area, you know that the change in direction is near.
- Securing your signals. Finally, you can additional signals to secure your strategy. Your possibilities are unlimited. For example, some traders use candlestick formations to predict when the market will turn around once it reaches one of the MFI’s extremes. Others use a moving average and invest once it turns around while the MFI is in an extreme area. Combining multiple indicators can be a great idea to make more money with very limited effort.
Conclusion
The Money Flow Index (MFI) offers binary options traders a simple and effective way of trading binary options. Depending on your risk tolerance, you can trade the MFI’s direction, overbought and oversold values, and divergences from the asset’s price movement.
Follow our instructions, and you are well on your way to success with the MFI.
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