Money Flow Index Strategy (MFI) | Backtest Analysis

Understanding volume and price, and how they can influence the market, is very important in trading. Since volume is the measure of activities in the market, traders can use the information provided to increase the probability of their trades. A great indicator that combines price action and volume is the money flow index. Now, what is a money flow index?

The money flow index (MFI) is a momentum indicator that measures the flow of money into and out of a security over a specified period of time by combining price and volume data. It oscillates between 0 and 100 and shows overbought and oversold conditions in the market. The indicator can be used for predicting potential price reversal points in the market.

This article focuses on the money flow index and how traders use it in their trading. At the end of the article, we provide a backtest of the strategy.

What is the money flow index?

The money flow index indicator or simply the MFI oscillator is a popular trading indicator used for predicting reversals in the market. It is used to gauge the buying and selling pressure within security. Just like conventional momentum-based indicators, the MFI oscillates between 0 and 100 and shows overbought and oversold conditions in the market.

One interesting thing about the MFI is that it does not consider only price but also includes volume. In fact, it can be considered a volume-weighted Relative Strength Index indicator because its formula is similar to that of the RSI but with volume added to the mix.

The MFI generates signals similar to those seen on several other technical indicators. This consists of producing oversold and overbought signals as well as the common bullish and bearish divergence signals. The overbought signal is given whenever the indicator is above 80, while the oversold signal is generated when the indicator is at 20 or below.

A bullish divergence MFI signal would occur when the price is creating lower lows or in a downtrend and the MFI is creating higher lows or in an uptrend. In the same way, a bearish divergence MFI signal would occur when the price is creating higher lows or in an uptrend, while the MFI indicator is creating lower lows or in a downtrend. To spot a divergence, you can employ the use of trendlines on both price and the indicator.

The money flow index indicator is commonly used to trade reversals. For this, traders typically look for a cool-off in momentum in an up