The similarities between Chaikin Money Flow (CMF) oscillator and the cash flow index (IMF) end with the idea that they are both commonly used by active traders to monitor money flow and/or momentum. Yes, although both are commonly used momentum indicators on stock charts, the math behind each indicator – and how traders interpret the 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 exponentially weighted moving averages (EMA) to analyze momentum. The MACD is usually calculated by subtracting the 26-period EMA from the 12-period EMA.
Key points to remember
- The Chaikin Money Flow Oscillator and the 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.
- The Money Flow Index uses volume in combination with recent price movements to determine trends and determine whether a market is overbought or oversold.
In the case of the Chaikin Money Flow, the indicator uses the difference between an exponentially weighted 3-day moving average of the accumulation/distribution line and the 10-day EMA of the accumulation/distribution line. During this time, 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 Amazon.com Inc (AMZN) chart above, the negative money flow (as indicated by the period between the two red rectangle) suggests that the directional bias is to the downside. A positive money flow is marked by the green areas on the Chaikin Money Flow Indicator and suggests the trend is up. If the indicator rises above 0.20 or falls below -0.20, it could suggest that the market is overbought or oversold.
Cash flow index
The Money Flow Index is quite different from the Chaiken Money Flow Oscillator as it uses volume in combination with recent price movements to determine whether momentum is up or down. Many traders consider 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 the MFI goes above 80, the market is overbought and should see a pullback. On the other hand, readings of 20 or less suggest an oversold market that could rebound. As you can see from the chart above, the cash flow index never moves above or below the key overbought Where oversold levels on AMZN’s chart as it did in the CMF example. When using the cash flow index, buy and sell signals are only generated when the index exceeds levels 20 or 80.
Since the Chaikin Oscillator and the Money Flow Index are calculated using different elements, it is not surprising to see that the trading signals are quite different. In general, it is essential to understand the underlying formula of any technical indicator before using it to generate buy and sell signals.