Scalping strategies in Forex rely on a low exposure risk concept and take into account the fact that smaller moves are frequent and easy to achieve than big ones. Chaikin Money Flow (CMF) is one such strategy employed as a confirmation tool when the stock trading is done based on trends.
What is Chaikin Money Flow (CMF Indicator)?
Chaikin Money Flow denotes assessment of momentum based on the fact that price trails volume. It is an institutional money flow indicator that denotes the volume-based average of distribution and accumulation over a particular span.
About Chaikin Money Flow Indicator
Chaikin money flow indicator founded in the 1980s by March Chaikin helps monitor the volume of money flow over a typical period of 21 days. It is basically an oscillator that fluctuates around a zero line, which is the absolute or base level of the indicator. Since it is volume-based, it is also termed as Chaikin Volume indicator.
The balance of selling or buying pressure is assessed based on the absolute level. Crosses over or below zero line also help in finding out money flow fluctuations.
The oscillator is shown as a red/green around the zero lines and range from -100 to +100. The green part indicates total buying pressure, while the red part represents selling pressure.
Distribution or accumulation signs of big institutions, which impact the price movement in future can be found by observing the persistence of money flow as shown by the red or green parts over 6 to 9 months. This is significant as the calculation does not need monitoring of order flow in the large institutions.
CMF formula is calculated in a series of steps that include the following: Money flow multiplier = ((Close value – Low value) – (High value – Close value)) / (High value – Low value)
Money flow volume is calculated next by multiplying money flow multiplier with volume for the specific period.
CMF is calculated as the average of daily money flow divided by the average of volume, which is given as CMF= (((Close – Low) – (High – Close)) / (High – Low)) * Volume) / Total(Volume, 21)
Understanding the Chaikin Money Flow
According to the Chaikin Money Flow definition, when the closing price is nearer to high value, there is more accumulation. If the closing price is nearer to a low value, there is more distribution.
In short, the Chaikin Money Flow indicator uses two significant factors for ascertaining a price moves sustainability, which includes strong closing of a stock and the low or high-volume level during the move.
The stock market money flow based on the Chaikin money flow index shows positive or negative low based on the closing performance of a stock. Therefore, Chaikin Money Flow is positive if the price movement is consistently closing above midpoint with increasing volume. And when the movement of price closes below the midpoint, the value of money flow will be negative.
Stocks are valued more by their performance when they are on high volume. Thus, daily money flow uses closing performance and the volume confirmation for finding direction as well as the magnitude of selling or buying pressure.
How to Use the Chaikin Money Flow Indicator
CMF indicator can be used in many ways.
Here are a few of them:
- While trading, you can use CMF to buy or sell stocks. When CMF is above zero, it signifies bullish signal showing buying pressure indicating accumulation. If CMF is below zero, it denotes bearish signal which is selling pressure indicative of distribution. So, you can buy when the value is above zero and sell when the value is below zero.
- The readings of the CMF index also help in identifying the duration and sustainability of the selling or buying pressure.
- The intensity of the CMF readings also help. Reading over 0.10 would indicate bullish signal, while above 0.25 would indicate robust buying pressure
Drawbacks of Chaikin Money Flow
CMF indicator is significantly used for assessing the strength of a specific trend, but it cannot give the entry or exit prices nor the stop-loss levels. It has to be used along with other indicators like RSI or MACD, which are price-based.
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CMF is an institutional buying indicator that can be a critical tool for timing and selection of stock. It has been used regularly for assessing the distribution and accumulation of stocks. The bullish or bearish divergences can help in assessing quick shifts in money flow. While it predominantly focuses on trend strength, it can be used to identify exit signals such as the change in the value of the CMF from negative to positive or vice versa. Use the money flow persistence to confirm a bullish trend. For divergences in money flow in the short term, there is a high risk, if you are considering pullbacks for the short term.