Since the Money Flow Index uses volume in its calculation, this indicator can prove effective as a divergence indicator. The theory is as follows:
The chart below of Microsoft (MSFT) shows the effectiveness of the Money Flow Index in detecting bullish and bearish divergences:
In the chart above, beginning on the left, Microsoft’s stock price is in a downtrend; however, the Money Flow Index is not going downwards, in fact, it is sloping upwards. This is a good illustration of a bullish divergence.
On the second half of the chart, Microsoft is making new highs, yet the Money Flow Index is making lower highs, a bearish divergence. Stock traders of MSFT might be advised to scale out of their position because money is flowing out of Microsoft stock.
The Money Flow Index is an interesting technical analysis tool due to its ability to incorporate both price and volume into its calculations.
Other technical analyis tools similar to the Money Flow Index, is the On Balance Volume indicator and the Chaikin Oscillator.
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