Tips for Using the Chaikin’s Money Flow (CMF) Indicator in Your Trading

Created in the 1980s by namesake Marc Chaikin, Chaikin’s Money Flow, or CMF for short, is a lesser-known trading indicator typically used to measure the trend strength of a financial asset.

Designed as an oscillator, where a value fluctuates between two extremes, Chaikin’s Money Flow attempts to compare current levels of buying pressure vs selling pressure, then assigns a score between -100 and +100.

Similar to other oscillators like the Relative Strength Index (RSI), traders can incorporate Chaikin’s Money Flow readings into their trading strategy to confirm existing trends or screen for potential reversals.

As shown above, Chaikin’s Money Flow is an oscillator, meaning its value fluctuates between two extremes, in this case, -100 and +100.

Comparing accumulation (buying pressure) vs. distribution (selling pressure) across the past twenty-one candles at default, CMF then assigns a score between -100 and +100, with -100 being the most bearish and +100 being the most bullish.

Although it is virtually impossible for any instrument to reach either extreme, a continued trend of higher CMF readings would suggest money is flowing into the market, indicating higher prices. The opposite would be true for a continued trend of lower CMF readings.

A baseline also exists at the zero level, helping separate bullish and bearish territory.

As a part of any balanced trading system, Chaikin’s Money Flow has many potential uses. Here are a few examples:

1. Entry indicator - If the CMF crosses and closes either above or below the zero line, this could signal that an existing trend will continue or indicate a potential reversal.
2. Exit indicator - If you are holding a long position and the CMF crosses and closes below the zero line, this could suggest an existing bullish trend has been exhausted, and your existing long position should be closed. The opposite would apply if a short position is held.
3. Volume indicator - Recent market volume levels are considered as part of Chaikin’s Money Flow calculation method. As such, CMF can be used to ‘pre-screen’ potential trading opportunities, ensuring enough volume for the market to trend. For example, if the CMF is moving neither convincingly up nor down, this could suggest insufficient volume for the market to trend.
4. Divergence analysis - As prices rise or fall, Chaikin’s Money Flow can be expected to typically follow suit. In some circumstances, however, instrument prices can increase while the value shown by Chaikin’s Money Flow decreases and vice-versa. Traders better know this phenomenon as divergence and, in this example, could suggest either a pullback or a change in trend.

The value of Chaikin’s Money Flow is determined by two factors: closing performance and volume confirmation. The formula is as follows:

In summary, CMF first calculates the total accumulation (buying pressure) vs. distribution (selling pressure) and then divides it by total volume. By default, this calculation is completed over a 21-period.

Within the price action of any instrument, a single candle will build a range between the highest and lowest price achieved. Where in this range price is at candle close forms half the equation for determining CMF value:

• Price closes towards top of candle range indicates ‘strong’ closing performance, higher CMF score
• Price closes towards bottom of candle range indicates ‘weak’ closing performance, lower CMF score

In the image above, example 1 shows ‘strong’ closing performance, where price consistently closes towards the top of the candle’s range. Example 2 shows ‘weak’ closing performance, where price consistently closes towards the bottom of the candle’s range.

It is important to note that despite achieving the same material change in price, the right example would still report a higher CMF reading than the left, purportedly showing a higher level of ‘positive money flow.’

To quote the Chaikin Analytics website¹, ‘Not all price moves are created equal.’

With liquidity known colloquially by traders as the ‘life-blood’ of the market, it would make sense that price movements seen during high trade volume are the most insightful, especially when attempting to speculate on future asset performance.

In the image above, price action is the same in examples 1 and 2, but it would still result in two different CMF readings.

This difference can be explained when considering the level of market volume seen in both examples:

• ‘Strong’ closing performance + high market volume indicates ‘positive money flow’, higher CMF score
• ‘Weak’ closing performance + high market volume indicates ‘negative money flow’, lower CMF score

In a nutshell, the closing performance and respective volume levels are considered when calculating Chaikin’s Money Flow value and whether the market is skewed more bullish or bearish.

• Like any other form of analysis, Chaikin’s Money Flow is likely to work best when used as part of a tested and balanced trading system. Traders should look to build ‘confluences’ within their trading strategies, where multiple forms of analysis, either technical or fundamental, come to the same consensus of long or short.

• In line with conventional technical analysis wisdom, Chaikin’s Money Flow will typically work more reliably on higher timeframes, where trends in price action are seen to last longer and, importantly, change less frequently. When using the CMF, traders may wish to use multi-timeframe analysis to understand longer-term market direction better.

• Despite being a valuable tool in determining trend strength, Chaikin’s Money Flow is not without limits. It should be noted that Chaikin’s Money Flow is a lagging indicator, and its readings may not always represent the most recent price changes.