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Understanding Chaikin Money Flow Index

This is another indicator that combines the price movement with volume.

ET Bureau|
Last Updated: Jan 03, 2020, 10.34 AM IST
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The price ending the day’s close to the day’s high shows the strength of the bulls, while if it happens at the lower end of the range, it reveals the strength of the bears.
The previous issue covered the volume indicator On Balance Volume (OBV). This issue covers another volume-based indicator, Chaikin Money Flow Index (CMFI). CMFI is developed by Marc Chaikin. This is another indicator that combines the price movement with volume. However, the computation method here is distinctly different from that of OBV. In the case of OBV, the strength of the counter is measured based on its closing price change, i.e., if it has gone up or down compared with the previous day’s closing. In CMFI, the strength is measured based on the point at which the closing occurs on that day. The price ending the day’s close to the day’s high shows the strength of the bulls, while if it happens at the lower end of the range, it reveals the strength of the bears.

Calculation - CMFI is calculated using three- step process and the formula to calculate a 10-day CMFI is given below:

1. Money flow multiplier = {(Close –low) – (high– close)} / (high – low)

2. Money flow volume = Money flow multiplier × volume for the period

3. 10 period CMFI = 10 period sum of money flow volume / 10 period sum of volume

The money flow multiplier tries to identify where the closing takes place. If it is above the half-way mark of high-low range, the money flow multiplier will be positive, otherwise it will be negative. The money flow multiplier will be +1 if the closing occurs at a high, and -1 if the closing occurs at a low. All you have to do now is to calculate the weighted average of these money flow multipliers by using the volume as weight. The last two points given in the formula explain this. Though you can compute CMFI for any time period, the commonly used one is 21 days, which is typically the number of trading days in a month.

Interpretation - This combination of volume and price helps CMFI to determine the strength of bullish or bearish moves in a counter. Chaikin’s formula is such that the interpretation of this indicator becomes easier. Hence, a reading above zero (in positive territory) is treated as bullish, whereas a reading below zero (negative territory) is treated as bearish. The level of the oscillator shows the strength of bullish / bearish pressure. For example, the CMFI reading above +0.25 or below -0.25 indicates that the bullish / bearish fervour is getting too much. In other words, the counter is in the overbought /oversold situations and may reverse the direction soon (similar situations can be seen in the Nestle chart).

Drawback -
Though the CMFI is a very good oscillator to follow a trend, it is not free of drawbacks. The most prominent among these is that it ignores the price gaps. If one ignores the closingto-closing changes, it may result in the CMFI sometimes disconnecting with the price. For instance, the CMFI can rise in a day when the price falls with a gap and with high volume.

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