What is Chaikin Money Flow (CMF)?
Chaikin Money Flow (CMF) is an indicator created by Marc Chaikin in the 1980s to monitor the accumulation and distribution of a stock over a specific period. The standard CMF period is usually 21 days. The indicator ranges between the results of +1 and -1, and any crosses above or below 0 can be used to identify the changes in money flow, as well as buying or selling momentum.
Sustained selling of a stock closes in the lower half of the daily range and pushes the indicator below zero. Also, sustained selling of the stock closes in the upper half of the daily range, pushing the indicator below the zero line. When the indicator fluctuates around the zero line, it means that the stock shows a minimal trend, and both sides of the trend are evenly matched. Traders use the CMF system as an essential tool for identifying the trends of the stocks being traded.
Calculating Chaikin Money Flow
The value of Chaikin Money Flow is calculated in the following three steps:
1. Money flow multiplier
The first step is to determine each period’s money flow multiplier as follows:
Money Flow Multiplier = ((Close value – Low value) – (High value – Close value)) / (High value – Low value)
2. Money flow volume
The next step is to calculate the volume of money flow by multiplying the volume for the period and the money flow multiplier obtained in step one. It is usually calculated at the daily level, but it can take other time variations like hourly or weekly.
Money Flow Volume = Money Flow Multiplier x Volume for the Period
The last step is to calculate the CMF value. Simply divide the daily money flow over a certain period of time by the sum of volume for the same period. The default number of periods for CMF is usually 21 days, which represents the price data for the past month. The formula is as follows:
CMF = 21-day Average of the Daily Money Flow / 21-day Average of the Volume
Most trading software and charting platforms nowadays include the CMF indicator. Most platforms express the indicator as a decimal by dividing it by 100, while other platforms will indicate it as a value between 0 and 100. It means that a value of 0.45 on one trading platform and 45 on another platform will mean the same thing.
Trading with the Chaikin Money Flow (What to Look Out for)
Here are some of the signals that traders can observe when trading with the Chaikin Money Flow:
Traders can draw trend lines on the indicator and spot possible breakouts on the chart. A trader must accurately identify a trend since it gives them confidence during trading that the trend will most likely continue.
For example, when there is a continuous buying period (when the CMF value is above zero), the trend is considered bullish and indicates that the price will continue to rise with the trend. However, when there is a continuous selling pressure (CMF value below zero), it points to a bearish trend and indicates that the price will continue on a downward trend.
Crosses can be observed on the chart when the Chaikin Money Flow intersects the zero line either from above or below. The crosses may be an indication of a possible trend reversal or strong trends when the readings are strong (e.g., +0.25/-0.25).
The crosses may be bullish or bearish. Bullish crosses occur when the CMF crosses the zero line from below, and stock prices continue on an upward trend. Bearish crosses occur when the CMF crosses the zero line from above, and prices continue to fall.
Sometimes, false signals may occur when the crosses are only brief and relying on such signals will result in losses. Traders can combine the CMF indicator with another indicator that measures the strength of the trend, and by analyzing the previous performance of the specific stocks.
Divergence occurs when the price action lacks a corresponding change in the CMF indicator. It can be observed on a chart when the indicator reaches a higher high, and the price reaches a lower low. When a divergence trend is observed, it shows a higher likelihood of a pullback occurrence.
In normal circumstances, when the price action achieves a higher high, the money should be rise as well (turn green). On the other hand, when the price action achieves a lower low, the money flow should follow suit (turn red).
Shortcomings of Chaikin Money Flow
The Chaikin Money Flow indicator is predominantly used as a confirmation tool to help traders identify the strength of a trend. Therefore, it is not a trading system that can help traders implement stop-losses and find profitable exits. Instead, traders can interpret the information produced by the Chaikin Money Flow and use it to implement a stop loss when the trend is losing strength.
CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful: