Chaikin Money Flow

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Introduction

Trading systems expert Marc Chaikin specializes on building computerized trading and investment models based upon the study of supply and demand in the stock and commodities markets. Chaikin technical research was build upon the on the ideas and research of technical analysis legends Joe Granville, Larry Williams and David Bostian. The Chaikin Money Flow Indicator (CMF) was one of the indicators that came as a result of his research.

The Chaikin Money Flow (CMF) measures the amount of money flow over time. CMF is used to study the volume of money flow and form the basis for an Accumulation Distribution Line. The Chaikin Money Flow does not tally a cumulative total money flow volume instead it simply sums the money flow volume for a specific trading period. Most analysts use 20 days as the default period for CMF. The Chaikin Money Flow line will fluctuate above and below a zero line similar to many other oscillators. Technical analyst can use the CMF indicator to study buying or selling pressure to help them forecast trend direction.

Formula

The Chaikin Money Flow indicator can be calculated in three simple steps. The first step is to calculate the Money Flow Multiplier (MFM) for a specified period. Secondly multiply this MFM by the period's volume to find Money Flow Volume (MFV). Lastly sum the MFV for the periods and divide by the period sum of volume. Assuming that we use 20 periods, CMF will be calculated as:

  1. MFM= [(Close - Low) - (High - Close)] / (High - Low)
  2. 2. MFV= MFM x volume for the period
  3. 3. 20-period CMF = 20-period Sum of MFV / 20 period sum of volume

Looking at the formula we see that each period's MFV will depend on the MFM. The MFM will be positive when prices are in the upper a half of the trading range and negative when prices are in the lower half.

The CMF formula creates an oscillator that fluctuates between -1 and +1. The CMF line will spend the majority of the time between extreme levels and it is fact extremely rare for the oscillator to reach these extremes. Just to clarify this point, for the CMF indicator to reach the top or bottom of the oscillator would take 20 consecutive data points on the high for a 20-day Chaikin Money Flow to reach +1 and the opposite to reach -1.

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Interpretation

The Chaikin Money Flow measures buying and selling pressure for a given period of time. A move into positive readings indicates buying pressure, while a move into negative readings indicates selling pressure. Traders and analysts can use the Chaikin Money Flow to confirm price action of the stock. Positive CMF would confirm an uptrend and a negative CMF the opposite.

Most technical analyst and traders will simply use the Chaikin Money Flow to help them determine whether or not a stock is trending higher or lower. The astute analyst and trader will also use the CMF to determine if a stock is not only in the accumulation phase, but how strongly the stock is being accumulated.

Zero Line Crosses

Buying and selling pressure is simply defined if the CMF index has been above or below zero for the several preceding months. If the CMF indicator is crosses above 0 from below, it is considered bullish and traders should look to trade from the long side. Conversely if the CMF line is below 0 from above, it is considered bearish, traders should look to trade from the short side.

 

In the chart of Alcoa we see in late 2009 that CMF indicator cross below the zero line suggesting a trend reversal. AA shares peaked not very long after the CMF indicator became bearish.

Trend Lines

Traders and analyst can draw trend lines on the CMF indicator to aid them in their analysis. By monitoring how many periods the CMF line has been positive or negative readings analyst can gauge the strength of the trend. Traders will interpret that when the CMF has been positive for several months as a sign of sustained accumulation. The intensity of buying pressure is represented by how high the CMF reading is, the higher the reading the greater intensity. The more positive and higher is more intense buying pressure and accumulation.

In the AA chart below, traders would have used the CMF to gauge the strength of the current trend. From August 2010 we see that the CMF line followed a nice up trend line until the CMF line peaked in January 2011. Traders would have been watching for a break of this up trend line to exits longs.

 

Divergence

As with many oscillators, analysts and traders will watch for any divergences between price movement of the stock and the indicator. Bullish divergence is defined when the CMF indicator makes a higher high, while the price action makes a lower low. This is interpreted that there is less selling pressure driving shares lower suggesting an end to the current downtrend. Bearish divergence is the opposite of the bullish divergence.

 

In the Alcoa chart above, note how the CMF line peaked in August 2009 and proceeded to move lower, while the AA continued to trade higher topping out in January. Analyst and traders would have viewed the move from with August to January with suspicion and avoided AA on the long side.

Whipsaws

One weakness of the CMF line is it is prone to whipsaws as the indicator will move back and forth between positive or negative readings. To avoid whipsaws, some analyst suggest using -.05 and +.05 levels as opposed to the zero line to filter out potential whipsaws. While filters can help reduce whipsaws, they will not entirely eliminate false signals.

 

Conclusions

Chaikin Money Flow is a good oscillator and it is easy to understand for those who want to study buying and selling pressure of a stock. Its core philosophy is that money flow is bullish when the CMF is positive and the bearish when the CMF is negative. Divergences between the CMF indicator and prices can alert traders that current sentiment is about to change. The Chaikin Money Flow indicator is unique in that it uses price and volume in its analysis as opposed to using only price or volume alone. By incorporating both, the CMF provide analyst with a different perspective than most other indicators. Like many other oscillators, traders can improve their performance by using the CMF in conjunction with other indicators, such as the RSI. Overall the Chaikin Money Flow indicator is a good tool for identifying buying and selling pressure.