"MFI Don't lie."
The Money Flow Index (MFI) is my favorite indicator. It's an absolute crucial tool for every Options Trader to have. I never perform technical analysis without it and I live by the rules of the flow. The MFI was created by Gene Quong and Avrum Soudack. It closely resembles Relative Strength Index(RSI) except it adds volume into the calculation instead of just the price. Its calculation is quite complex but thankfully we don't have to worry about any of that.
So, what exactly is Money Flow Index and how can it help you in your trading?
Simply put, the MFI helps a trader determine when the price of the stock is oversold or overbought. These levels are easy to to understand:
MFI levels 75 or above is overbought
MFI levels 25 or below is oversold
When the price becomes oversold it usually means there has been a recent sell off. As sellers pile on their orders it eventually brings the price back down to attractive levels. This is when the buyers take over and slowly as the flow of money comes in we see the MFI rise and eventually tap into the overbought zones.
In Options Trading we want to buy calls when MFI is oversold and buy puts when MFI is overbought
Here is how the Money Flow Index looks on your chart:
Using the chart above here is how the MFI can help us time our entries and exits appropriately.
First off, you should know that this is a five minute candlestick chart. The MFI tells us when we need to buy and sell our calls and puts. As you can see each of these trades would have been very profitable. A 20-80 cent move on a stock this price means big money for our option contracts!
It's important to pay close attention to the MFI peaks and troughs. They begin to form trending lines of their own that reflect the price of the stock. As shown in the image below our MFI is aligning with the movement of the price:
The great thing about MFI is it pairs so well with just about any indicator. My favorite is combining with The Keltner Channels
You can read more about timing your entries and exits with the 1 and 5 minute MFI here.
I hope you find as much success with the MFI as I have. Good luck and happy trading folks!