The Chaikin Money Flow indicator was developed by Marc Chaikin to measure the money flow volume over a pre-specified period. Traders can use the Chaikin Money Flow to identify levels of increased money flow into a financial instrument which is correlated with the supply and demand for the instrument.
Chaikin Money Flow fluctuates between -1 and +1, and a cross above or below the zero-line can be used to identify changes in the underlying money flow and the buying and selling pressure, respectively. The following chart shows the 20-periods Chaikin Money Flow indicator plotted on the EUR/USD currency pair on the daily timeframe. The black line represents the zero-line.
Calculation of Chaikin Money Flow
The CMF is based on the money flow over a specified period of time, and is calculated with three steps. The standard setting is to take into account the last 20 periods, but you can adjust this to accommodate your own trading style.
Step 1: Calculate the Money Flow Multiplier for each period
Money Flow Multiplier = [(Close – Low) – (High – Close)] / (High – Low)
Step 2: Calculate the Money Flow Volume by multiplying each Money Flow Multiplier with the period’s volume
Money Flow Volume = Money Flow Multiplier x Volume for the Period
Step 3: Calculate the Chaikin Money Flow by dividing the 20-period sum of Money Flow Volume by the 20-period sum of volume
20-period CMF = 20-period Sum of Money Flow Volume / 20 period Sum of Volume
How to Interpret Chaikin Money Flow
Although the indicator fluctuates between -1 and +1, it will reach those extreme values very rarely. Instead, the indicator fluctuates between the values of -0.50 and +0.50 most of the time. Chaikin Money Flow gives a valuable insight into the buying and selling pressure behind a financial instrument.
A cross of the zero-line from below indicates increased buying pressure, and a cross of the zero-line from above indicates increased selling pressure. This information can be used by traders to confirm the strength of the underlying trend – a positive value of Chaikin Money Flow adds to the strength of the current uptrend, while a negative value of Chaikin Money Flow adds to the strength of the current downtrend.
Basically, a buy signal is triggered with the cross of CMF into positive territory (above zero) which indicates increased buying pressure (demand), while a sell signal is triggered with the cross into negative territory (below zero) which indicates increased selling pressure (supply).
However, it’s important to note that the nature of Chaikin Money Flow’s calculation can create many whipsaws by waiting for the indicator to cross above or below zero. The problem here is that CMF will often cross the zero-line only to return to its previous positive/negative territory after a short period of time.
Traders can avoid these false signals by adding a small buffer to the buy and sell signals, which can eliminate many of the false signals over time.