When it comes to trading we want to know if money is flowing into or out of a stock.
The last thing we want to do is buy a stock where money is flowing out, right? Of course not… It’s a great way to lose money. Instead, we want to buy if we’re seeing money flow in.
It’s why we pay close attention to the Money Flow Index (MFI) – a popular indicator that indicates the strength of money flowing in or out. Money flow is considered positive when prices rise, and negative on price declines with selling pressure. It’s also helpful when confirming price trends, producing signals of potential reversals from overbought and oversold conditions. If MFI is below 20, the stock is considered oversold. If MFI is above 80, the stock is considered overbought.
About 80% of the time, when Money Flow dips well into oversold territory with a well-respected stock, it’s likely to bounce higher. Notice what happened on this two-year chart of Bristol Myers Squibb (BMY).
After falling in recent months on earnings and guidance, the stock became excessively oversold with regards to money flow indicators. In this case, too much money flowed out, which created an unsustainable situation. It also told us to look for a potential bounce in the underlying stock, as money flow became far too negative.
About 80% of the time, when Money Flow falls to 20 or less on BMY, it marks the bottom of trend. On a move in MFI above 20 in August 2015 and again in February 2017, Money Flow was spot on, and called the bottom of trend. Of course, it’s always best if Money Flow is only used to confirm other momentum indicators. As with all technical indicators, MFI should not be solely used. It should be used to confirm other indicators along the way.