Understanding the Basics of MFI
An overbought or oversold signal in an asset can be identified with the help of the Money Flow Index (MFI), a technical oscillator that considers both price and volume. The oscillator ranges from a scale of 0 to 100. The Money Flow Index is an alternative to traditional oscillators like the Relative Strength Index (RSI) because it uses price and volume information. This is why some market watchers refer to MFI as "volume-weighted RSI." Overbought is defined as an MFI reading above 80, while oversold is defined as a reading below 20, although levels of 90 and 10 are also used. If the indicator and the price are not aligning, it is considered that there is something to take note of.
In addition, it can be used to identify divergences that foretell a reversal in the price trend. For there to be a divergence, the oscillator must be heading in the opposite direction of the price. This indicates that the current price trend may be changing direction. Using multiple waves in both the price and the MFI allows traders to look for larger divergences. In addition, trading opportunities can be indicated by the overbought/oversold levels. We rarely see moves below 10 or above 90. When the MFI rises above 10, traders know it is time to buy, and when it falls below 90, they know it is time to sell.
There is a robust correlation between the MFI and RSI. In contrast to the RSI, MFI takes volume into account. Proponents of volume analysis often assert that it is a leading indicator. For this reason, they think that MFI will be a timelier indicator than the RSI in providing signals and warning of potential reversals. No single indicator is superior to any other; each indicator uses a slightly different combination of factors to arrive at its signal.
The MFI can generate erroneous readings. Sometimes a good trading opportunity will be signalled by the indicator, but the price will not follow suit, leading to a losing trade. A divergence, for instance, may not even result in a price reversal. This indicator may also miss a warning of a critical event. Traders should therefore employ multiple indicators and not rely solely on any one of them for analysis and risk management. Willing to know more? Visit Nifty Trading Academy today!
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