- January 15, 2022
- Posted by: CoachShane
- Categories: Trading Article, Trading Indicators
The relative strength index (RSI) and the money flow index (MFI) are both momentum oscillators and use different variables in their calculation.
The RSI is the more popular indicator of the two and uses the change in price as well as how fast that change in price is occurring.
The MFI also measures price change as well as the trading volume flowing in and out of the instrument.
Since the RSI is the more popular, the question of an indicator being better than the RSI is a good one. Just because an indicator is popular, doesn’t make it the best one to use.
With the inclusion of trading volume, does that make the money flow index better than the RSI? They are interpreted in a similar way and the best way to decide which to use, is to compare them.
How Does The Money Flow Index Work?
The MFI will, like the RSI, oscillate between the 0 – 100 extremes.
The difference is the MFI has oversold and overbought zones at the 20 and 80 levels while the RSI is 70 and 30.
Essentially, when the oscillator reaches one of the those levels, traders will look for a reversal in price.
For example, a reading of 80 would indicate the the instrument is overbought and prime for a reversal. It is just a sign, not a guarantee, and a trader would want to confirm with price action.
- A rise in the MFI will indicate that buying pressure is increasing and potentially a strong trend upwards – positive money flow
- A drop in the MFI will indicate an increase in selling pressure – negative money flow
The buying and selling pressure is not just measured with price, it is also measured with increases and decreases in volume.
No different than the RSI, when price is heading in the opposite direction of the indicator (negative money flow/positive money flow), we could be looking at bullish or bearish divergence.
This example has the stock price making a higher high while both the money flow index, the top indicator, and the RSI are putting in lower highs. Both indicators are set to 14 periods.
A trader would interpret this as the upside momentum of the instrument is running dry. If long, traders would aggressively manage their protective stops. If not in the market, traders would look to price action to confirm that momentum is in fact lessening in the price action.
How The MFI Is Calculated
It is important to know how an indicator is calculated or at the very least, have an idea of what it is really measuring. We live in a time when virtually everything can be programmed and for traders, we would just pop the indicator on the chart.
If you are a trader that believes that volume is important to trading, then you will be happy to know that volume is used with the MFI.
There are several steps involved in the Money Flow Index calculation and includes the typical price, positive or negative flow, and money ratio. The period of time generally used in the MFI calculation is 14 periods.
This is a much different calculation than the RSI but essentially we are looking at momentum with the addition of volume to aid in measuring that momentum.
MONEY FLOW INDEX VS RSI
Let’s look at a few stock charts using both indicators to see what information they would have given.
- Both MFI and RSI gave an early warning to an overbought stock that quickly reversed
- We have both showing an oversold condition and bullish divergence
In this head to head battle, both indicators gave the same alert to the state of the instrument including oversold levels,
This is a daily chart of TSLA and is currently in a trading range.
The MFI gave an oversold reading at the low of the trading range while the RSI couldn’t break far enough. The price reversal is clear on this chart as is the reversal candlestick off the low.
A trader who looks for oversold signals in the RSI and a potential reversal, would have missed this chart.
Looking at a day trading chart time frame of 15 minutes, we some things that are interesting.
Both oscillators picked up the first oversold condition that lead to the run up in price.
In the middle, MFI picked up bearish divergence while the RSI showed the overbought level was violated.
Both indicators gave a signal at the same location of the chart.
The difference is the money flow index gave us divergence while the overbought condition came from the RSI.
MFI VS RSI – Wrap
Obviously this was not an exhaustive test and was designed to show both indicators at the same point on a chart.
But let’s remember, both indicators are described as momentum oscillators and therefore looking how they react to changing momentum, is important.
I am not a huge believer in using oversold conditions or overbought readings in my own trading. A market can stay in those conditions, as noted by an indicator, for a long period of time.
However, divergence is another story.
If price is making a higher high in an uptrend but the MFI, using volume as well as price, is showing negative money flow, we can quickly see if that is valid.
We can expect that within a reasonable amount of time, price will either decline or make further highs. I personally like the consistency of the MFI with showing divergence as opposed to the RSI.
This hourly chart of crude oil shows the MFI showing bullish divergence – positive money flow. The RSI doesn’t give us any heads up of a potential move higher.
If I was to have to choose one, I would go with the money flow index over the RSI. I say that because of not putting much stock in trading an oversold/overbought instrument.
I can know fairly quickly if the oscillator is giving a reliable trading signal because price will soon follow. For a momentum indicator, that is what I want.
Which one do you prefer?