Money FlowDefined with Examples & More
What is Money Flow?
Money flow is a gauge used to study the movements of prices, particularly future prices.
It is a technical indicator that is based on supply and demand.
Money flow will provide a clear graphical representation of prices if it is an uptick or downtick movement.
Whatever the price movement is in the market, whether it is downward or upward, the money flow generally signifies the surplus in the supply or demand.
The indicator traders may use to confirm that the money flow has a positive or negative result by comparing the present value to the previous value.
An excess in demand equates to a positive difference between the uptick dollar volume and the downtick dollar volume, assuming that uptick traders are motivated by buyers and downtick traders by sellers.
Understanding Money Flow
A positive money flow occurs when the price increases compared to the previous price.
A negative money flow, on the other hand, happens when the current market price has decreased as compared to the previous day.
If present prices remain the same, no money flow occurred with the trade.
Another form of money flow representation is multiplying the trade volumes by the transaction price.
If the trade has happened during an uptick, it results in a positive money flow.
If it has occurred during a downtick, the money flow results in a negative.
If there had been more stock purchases during an uptick than a downtick on a particular day, the result is a positive money flow due to the investors’ stock purchases on a premium.
When it comes to determining future returns, many investors depend on money flow which considers trading volume as the basis of leading prices and therefore provides insight on trading opportunities.
Determining Money Flow
Money flow is calculated using the averaging method. The resulting average of the closing, low, and high prices will be multiplied by the daily shares volume.
See an illustrative example below:
| Day 1 | Day 2 |
| High: $74 | High: $76 |
| Low: $68 | Low: $65 |
| Closing: $71 | Closing: $72 |
| Daily Volume: 320,000 shares | Daily Volume: 160,000 |
| Money Flow = 320,000 x 71 = $22,720,000 | Money Flow = 160,000 x 71 = $11,360,000 |
The example above illustrates a negative money flow between Day 1 and 2.
Money Flow and Money Flow Indicators
One of the indicators traders often used to confirm the best entry and exit point decision is the Chaikin Money Flow Oscillator, named after Marc Chaikin. He used the closing price and volume of shares traded to indicate the current and future possible price movements.
Chaikin’s Money flow oscillator stands out from other indicators because some of its concepts are similar to the Moving Average Convergence Divergence.
Like the MACD, Chaikin also shows the market price momentum with the help of an exponential moving average.
When traders want to determine the overbought or oversold points in one trading period, they use another indicator that considers the transaction price and trade volume – the Money Flow Index (MFI). Prices are overbought when the value reaches 80 or more.
While an oversold condition results in a value of 20 or lower.
The Money Flow is used alongside other technical indicators to prevent pitfalls in trading.
Global Money Flow
Traders must consider the money flow in the global economy to have full knowledge of the risks and rewards brought by investing in a stock market.
For example, global equity investing in the mid-1980s in the European stock market was not as thrilling because prices continued to rise due to the significant pension funds the US and UK consistently showered in the market.
Because of pension funds, the two countries’ market standing in the global economy has increased.
Traders are allowed to a broader market trading but with relative risk, which is having no assurance of what will be the future market movements.
To better understand the risk and reward of investing in a global market, the traders must know several factors like the cash flow statement, liquidity, and market attractiveness.
Drivers of Money Flow
Factors to be considered are demographics, cyclical liquidity and economic fundamentals.
Demographics
The age distribution determines the type of investments most availed of in one country.
For example, the rate of aging individuals in one country is significantly larger than that of the youngsters which means that a larger rate of the investments in one country is for pensions.
If such are used for equity investment, there is a higher probability of pensions doubling their amounts.
A larger portion of the population in the United States is aging individuals or the baby boomers. Thus, a relatively higher rate of savings is also recorded.
This situation affects the money flow in the said country because they do not aim to spend but to save more.
Cyclical Liquidity
To understand the function of the Central Bank relative to money flow, cyclical liquidity is the practice used.
The measurement of a Central Banks’ operation on a national or international level is by measuring its liquidity.
Traders evaluate the performance of the Central Bank in different asset classes and at every stage of the liquidity cycle.
Economic Fundamentals
Other than technical indicators, investors must consider studying the fundamental factors that affect the economic status of one country.
By considering technical and fundamental factors, traders may have a solid gauge when trading in a stock market.
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Harvard Business School "HOW TO READ & UNDERSTAND A CASH FLOW STATEMENT" Page 1 . August 23, 2022
Harvard Business School "CASH FLOW VS. PROFIT: WHAT'S THE DIFFERENCE?" Page 1 . August 23, 2022