There are hundreds of indicators you can use to trade in the financial market. As we have noted before, these indicators are developed using complex mathematical calculations.
In the past few week, we have looked at indicators like the Relative Strength Index (RSI), Momentum, and Bollinger Bands. This week, we will look at the Chaikin Money Flow (CMF) indicator, what it is and how to use it in the financial market.
What is the Chaikin Money Flow Indicator?
The CMF is an indicator that was developed by Marc Chaikin (as well as the Chaikin oscillator). The indicator measures the amount of money flow over a period of time. The indicator is the foundation of the accumulation and distribution indicator, which we looked at before.
The CMF indicator is found as a default in the MetaTrader trading software. When applied, the indicator is usually a line that moves up and below the centreline. The general idea of the indicator is that it sums the money flow volume for a specific period.
When applied on a chart, the Chaikin Money Flow is a single line that moves up and down. Indeed, it has a close resemblance to the A/D indicator. In the chart below, the CMF is shown in green while the A/D is shown in red. Therefore, if you know how to use the A/D line, the CMF will be an easy to use indicator.
The Chaikin Money Flow indicator is relatively easy to calculate. The first stage is to calculate the money flow multiplier. You calculate this multiplier by using the following formula.
|((Close – Low)) – (High – Close )) / (High – Low)
The next step is to calculate the money flow volume. This is calculated by multiplying the money flow multiplier above with the volume of that period.
Finally, you calculate the CMF by dividing the period’s sum of money flow volume with the period sum of volume.
As a trader, you need to select the period you will use. In most trading platforms, the volume used is usually 20. Still, you can tweak the number depending on your style.
Best way to Read the Chaikin Money Flow
Because of how the CMF indicator is calculated, it means that the line usually oscillates between +1 and -1. Still, it is very difficult for it to reach these extremes. This is because, for a 10-period CMF to reach +1, it would take 10 consecutive closes for it to reach +1.
The positive and negative numbers are interpreted as this: When the line is positive, it is usually an indication of more buying pressure. When it is negative, it is usually an indication of selling pressure.
There are two settings you should change when using the Chaikin Money Flow indicator. You can change the length of the indicator to suit your strategy. The default period that is used is 20. You can change this depending on your trading strategy and style. The next item that you can change is the colour of the indicator.
How to Use the Chaikin Indicator
Using the Chaiking Flow Indicator is relatively easy. First, you need to identify a chart that is not in consolidation mode. Consolidation happens when the price of an asset is struggling to find direction. As a result, it usually moves in a sideways direction. The CMF, as with other indicators, is usually not very good when the price is consolidating.
Second, you need to go to the settings of the indicator. You want to select your preferred period. In most cases, you can use the default of the indicator. Finally, you should apply the indicator in the chart.
When you do this, you should look at the historic movement of the CMF indicator. When the indicator is moving upwards, it is usually recommended to buy the asset. Similarly, you should sell the asset short when the indicator is moving downwards or when it is below zero.
CMF Practical Example
The chart below is a good example of the Chaikin Flow Indicator in use on the EUR/USD chart. There are black and green lines on the chart.
As you can see, the price tends to move upwards when the indicator is moving upwards. This is shown using the black lines below. The blue lines show that the price is moving downwards when the indicator is below the centreline.
Another way of using the indicator is to combine the indicator with other indicators. The one we prefer a lot is to combine it with a double Exponential Moving Average (EMA). This is when you combine a longer and shorter moving average.
This combination is usually great for finding reversals. When you use it this way, the CMF is used to confirm the new trend. This is shown on the chart below.
Using the Chaikin Money Flow in day trading
Unlike many popular technical indicators, the CMF is not commonly used by day traders. Instead, it is mostly used by long-term traders. The chart below shows the chart applied in a 15-minute chart, which is commonly among day traders. As you can see, the indicator does not tell a lot of information.
Therefore, if you are a day trader, we recommend that you use other indicators like the moving average and VWAP.
The Chaikin movement flow indicator is a relatively uncommon indicator. Not so much trader use it on a daily basis. Yet, it is a great indicator you can use to complement other indicators. It is also a good indicator you can use to identify divergencies and reversals.