Using Chaikin Money Flow (CMF) For Stock Trading

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Using Chaikin Money Flow (CMF) For Stock Trading

Chaikin Money Flow was developed by Marc Chaikin and is a primary used a confirmation tool for trend trading in stocks. It combines both price action and volume into one indicator, as the founder believes that volume leads price.

CMF moves above and below zero based on whether, on average, the stock is finishing in the upper portion of the daily range or the lower portion respectively. Each day is multiplied by volume, so a down day accompanied by big volume will result in a lower indicator reading than a down day on small volume.

While the indicator is typically used on daily charts, it can also be used on intraday charts where volume data is present. A 21-period indicator is commonly used, because it represents approximately 1 month worth of trading days. Multiples of this number are also used, such as 42, 63, 84, 126 or 252. For short-term trading a fewer number of periods will be favorable since the indicator will react quicker to trend changes. Longer-term traders will prefer a longer period CMF indicator.

One of the main ways to use Chaikin Money Flow is to confirm breakouts.

Isolate a resistance/support area where the price has had trouble getting above/below it on a number of attempts. Mark these areas as resistance or support.

When the price rallies through resistance, look for the CMF to confirm the breakout. CMF should be above zero. If it isn’t, it warns the breakout could likely fail.

When the price falls through support, look for the CMF to be below zero to confirm the breakout. If the price breaks support but the CMF isn’t below zero, the breakout is likely to fail.

Figure 1 shows an example on a daily stock chart. The price was hitting resistance just below $37, which it couldn’t get above on multiple attempts. Then, in October, first the CMF turned positive and then the price broke above resistance. Since the CMF was still positive it confirmed the breakout.

For those looking to go long (buy calls), the CMF could have helped solidify that decision.

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Figure 2 below shows how the indicator confirmed a downside breakout.

The stock had found support on a number of attempts just above $55. The CMF turned and stayed below zero even while the price rallied a bit, before eventually gapping below support. The negative CMF reading showed the uptrend was weak, and confirmed the downside breakout. That the CMF stayed below zero following the breakout also helped confirm the new downtrend.

For traders looking to go short the CMF would have given them confidence in their decision.

Final Word

The Chainkin Money Flow is a tool that uses both price and volume to confirm the trend or warn of weakness. It isn’t usually used to provide trade signals itself, rather it simply helps to confirm signals using other strategies, such as breakouts or trend trades. For long trades the CMF should be above zero, and for short trades the CMF should be below zero. This shows that momentum (price) and power (volume) are both moving in the same direction as the trade.

No indicator is perfect though. Always manage position size so that a single losing trade doesn’t significantly draw down your account

Chaikin Money Flow (CMF)

Contents

DEFINITION

Chaikin Money Flow (CMF) is a technical analysis indicator used to measure Money Flow Volume over a set period of time. Money Flow Volume (a concept also created by Marc Chaikin) is a metric used to measure the buying and selling pressure of a security for single period. CMF then sums Money Flow Volume over a user defined look-back period. Any look-back period can be used however the most popular settings would be 20 or 21 days. Chaikin Money Flow’s Value fluctuates between 1 and -1. CMF can be used as a way to further quantify changes in buying and selling pressure and can help to anticipate future changes and therefore trading opportunities.

HISTORY

Chaikin Money Flow was created by famed stock analyst Marc Chaikin. The Chaikin Money Flow has become closely related to two of Chaikin’s other famous indicators; the Chaikin Oscillator and Accumulation/Distribution.

CALCULATION

THE BASICS

Chaikin believed that buying and selling pressures could be determined by where a period closes in relation to its high/low range. If the period closes in the upper half of the range, then buying pressure is higher and if the period closes in the lower half of the range, then selling pressure is higher. This is what the Money Flow Multiplier determines (step 1 in the calculation above). The Money Flow Multiplier is what determines The Money Flow Volume and therefore, ultimately Chaikin Money Flow (CMF).

Chaikin’s Money Flow’s value fluctuates between 1 and -1. The basic interpretation is:

  • When CMF is closer to 1, buying pressure is higher.
  • When CMF is closer to -1, selling pressure is higher.

WHAT TO LOOK FOR

Trend Confirmation

Buying and Selling Pressure can be a good way to confirm an ongoing trend. This can give the trader an added level of confidence that the current trend is likely to continue.

During a Bullish Trend, continuous Buying Pressure (Chaikin Money Flow values above 0) can indicate that prices will continue to rise.

During a Bearish Trend, continuous Selling Pressure (Chaikin Money Flow values below 0) can indicate that prices will continue to fall.

Crosses

When Chaikin Money Flow crosses the Zero Line, this can be an indication that there is an impending trend reversal.

Bullish Crosses occur when Chaikin Money Flow crosses from below the Zero Line to above the Zero Line. Price then rises.

Bearish Crosses occur when Chaikin Money Flow crosses from above the Zero Line to below the Zero Line. Price then falls.

  • It should be noted that brief crosses can occur resulting in false signals. The best way to avoid these false signals is by examining past performance for the particular security that is being analyzed and even adjusting the thresholds accordingly. For example, instead of a Zero Line Cross, a technical analyst may use two separate lines such as .05 and -.05.

Unreliability

Chaikin Money Flow does have a shortfall in its calculation. The shortfall is that the Money Flow Multiplier, which plays into determining Money Flow Volume and therefore Chaikin Money Flow values, does not take into account the change in trading range between periods. This means that if there is any type of gap in price, it won’t be picked up on and therefore Chaikin Money Flow and price will become out of synch.

SUMMARY

Chaikin Money flow is a nice indictor that gives the technical analyst another view of Chaikin’s theories about buying and selling pressure. It should not necessarily be used by itself as a stand-alone signal generating indicator. CMF works well when in conjunction with additional indicators, especially those indicators that were also generated by Chaikin; Accumulation/Distribution (ADL) and The Chaikin Oscillator.

HOW TO USE IN TRADINGVIEW

  1. Navigate to https://www.tradingview.com/
  2. On the landing page, enter a symbol and click “Launch Chart”
  3. Within the Toolbar along the top of the chart select “Indicators” and choose the one you would like to add to your chart.
  4. To make changes to your Indicator you will need to access the Formatting Window.
  5. You can access the Formatting Window by either clicking on the Blue “Format” button in the Chart Header next to the Indicator name, or by right clicking on the Indicator in the chart itself and selecting “Format”.

INPUTS

Length

The time period to be used in calculating Chaikin Money Flow.

STYLE

Can toggle the visibility of the Money Flow Line as well as the visibility of a price line showing the actual current value of Money Flow. Can also select the Money Flow Line’s color, line thickness and visual type (Line is the default).

Can toggle the visibility of the Zero Line. Can also select the Zero Line’s value, color, line thickness and visual type (Dashes are the default).

Precision

Sets the number of decimal places to be left on the indicator’s value before rounding up. The higher this number, the more decimal points will be on the indicator’s value.

PROPERTIES

Last Value on Price Scale

Toggles the visibility of the Indicator Value on the vertical axis.

Arguments in Header

Toggles the visibility of the indicator’s name and settings in the upper left hand corner of the chart.

Scaling

Scales the indicator to either the Right or to the Left.

The Difference Between Chaikin Money Flow and Money Flow Index?

The similarities between the Chaikin money flow (CMF) oscillator and the money flow index (MFI) end with the idea that they are both commonly used by active traders to monitor the flow of money and/or momentum. Yes, while both are commonly used momentum indicators on stock charts, the math underlying each indicator—and how traders interpret signals—is quite different.

Chaikin Money Flow Oscillator

Created by Mark Chaikin, the Chaikin money flow oscillator is similar to the more widely used Moving Average Convergence Divergence (MACD) indicator because it uses two different exponentially weighted moving averages (EMAs) to analyze momentum. MACD is generally calculated by subtracting the 26-period EMA from the 12-period EMA.

Key Takeaways

  • Chaikin money flow oscillator and money flow index are both momentum indicators, but the similarities end there because the ways the indicators are calculated and interpreted are different.
  • Chaikin is similar to MACD in that both indicators use exponential moving averages in their calculations.
  • When the Chaikin money flow indicator is red, it suggests the market is in a downtrend and when it is green, the indicator suggests an uptrend.
  • Money flow index uses volume in combination with recent price movements to determine trends and to determine whether a market is overbought or oversold.

In the case of the Chaikin Money Flow, the indicator uses the difference between a 3-day exponentially-weighted moving average of the accumulation/distribution line and the 10-Day EMA of the accumulation/distribution line. Meanwhile, the accumulation/distribution line (also developed by Chaikin) is a separate indicator that attempts to quantify the amount of money coming in (volume) and its impact on stock prices.

As you can see from the chart of Amazon.com Inc (AMZN) above, negative money flow (as shown by the period between the two red rectangles) suggests that the directional bias is downward. Positive money flow is marked by the green areas on the Chaikin money flow indicator and suggests that the trend is upward. If the indicator rises above .20 or falls below -.20, it could suggest that the market is overbought or oversold.

Money Flow Index

The money flow index is quite different than the Chaiken money flow oscillator because it uses volume in combination with recent price movements to determine whether momentum is up or down. Many traders view this indicator as a volume-weight relative strength index (RSI), which is calculated using average price gains and losses over a period of time (usually 14 days).

Typically, if MFI rises above 80, the market is overbought, and due for a pullback. On the other hand, readings of 20 or less suggest an oversold market that may bounce. As you can see from the chart above, money flow index never moves above or below key overbought or oversold levels on the chart of AMZN as it did in the CMF example. When using the money flow index, buy and sell signals are only generated when the index moves beyond the 20 or 80 levels.

Since Chaikin oscillator and money flow index are calculated using different elements, it is unsurprising to see that the trading signals are quite different. In general, understanding the underlying formula of any technical indicator is essential before using it to generate buy and sell signals.

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