Last Updated on August 15, 2023
Chaikin Money Flow (CMF) is an indicator that gauges the buying (accumulation) against the selling (distribution) pressure of a security over a particular period.
Often compared with other technical indicators, such as On Balance Volume (OBV) and Money Flow Index (MFI), Chaikin Money Flow is a popular volume-weighted oscillator.
In this article, we look at the best ways to use the Chaikin Money Flow, explore strategies based on the indicator, and list its advantages and disadvantages. We will also compare the CMF to similar indicators like the OBV and MFI.
What Is the Chaikin Money Flow Indicator?
The CMF is based on the idea that the nearer the closing price is to a security’s high, the stronger the buying pressure (more accumulation has taken place). On the contrary, the closer the closing price is to the bottom, the stronger the distribution.
That said, the value of the CMF will be positive if the security’s price constantly reaches new highs above the bar’s midpoint when the volume is increasing. On the other hand, the indicator will turn negative if the security’s price continuously closes below the bar’s midpoint when the volume rises.
Developed by stock analyst Mark Chaikin, the CMF is similar to the Moving Average Convergence Divergence (MACD) indicator, which is more popular among investors and analysts. CMF is similar to the MACD because it utilizes two individual exponentially weighted moving averages (EMAs) to measure momentum.
CMF analyzes the difference between a 3-day EMA and the 10-day EMA of the accumulation/distribution line, which is actually a separate indicator Chaikin created to measure money inflows and how they affect security prices.
On a chart, the Chaikin Money Flow indicator can be valued between +100 and -100. Areas between 0 and 100 represent accumulation, while those below 0 represent distribution.
Cases when the indicator ranges above/below 0 for a period of 6 to 9 months (known as money flow persistency) can be signs of significant buying or selling pressures by large institutions. Such situations have a much more pronounced impact on price action.
How to Use the Chaikin Money Flow Indicator?
The Chaikin Money Flow indicator aims at identifying securities with sustainable price movements based on price and volume patterns. The CMF gives investors an indication of the strength of the security’s movement and whether it occurred in high or low volume.
As such, buying pressure or accumulation is illustrated by securities that closed at high levels on high volume. Conversely, distribution is represented by securities with low closing prices on high volume.
When looking for appealing buy opportunities, investors seek securities with strong money flow persistency. Although investors shouldn’t immediately disregard securities where CMF is below 0, it is advised to prioritize instruments with strong money flow persistency.
Chaikin Money Flow Indicator Strategy
Investors also use CMF to confirm the price breakout. For instance, if the price of a security breaks above the resistance line, investors wait for the CMF value to go above 0 to confirm the breakout direction. And vice-versa.
The CMF sends a sell signal if a security’s price reaches a higher high into overbought regions. If the indicator drops to a lower high, it signals a downward movement.
Similarly, if the price action falls to a lower low into oversold areas and the CMF diverges with a higher low and starts to surge, this is considered a buy signal. When security’s price and the CMF advance in opposite directions, this indicates a possible trend reversal.
For instance, if the price falls to a new bottom and the CMF doesn’t follow, we have a bullish divergence – the start of a potential upward trend. A bearish divergence, on the other hand, is when the price hits a new high while CMF remains in place or even drops.
The CMF also forms crosses when the indicator intersects the 0-line, which suggests a trend reversal. Bullish crosses emerge when the CMF intersects with the 0-line from below, and the security price continues upward. On the other hand, bearish crosses occur when the CMF crosses the 0-line from above, and the price continues to decline.
In some cases, crosses can send fake signals. This happens when the CMF barely crosses the 0-line and then retreats. To address this, some investors prefer to wait for the CMF to move at least 5 points above the 0-line before taking action.
While many investors find CMF useful when developing their investing strategy, it is rarely used as a standalone indicator.
Chaikin Money Flow vs. OBV
The CMF is often compared with other indicators used for monitoring money flows and momentum, such as the On Balance Volume (OBV) and Money Flow Index (MFI). The OBV is a momentum indicator that uses volume to forecast price changes.
The idea behind OBV is based on the impact of institutional investors and retail investors on trading volume and market prices.
The OBV typically follows the security’s trajectory, and when a positive or negative divergence occurs, it usually serves as a sign for investors to make a move. The OBV and the CMF differ in the sense that the former measures are based on the difference in closing prices across multiple days, while the latter measures are based on the closing price of each trading day.
It is important to note that the OBV can often produce fake signals. This is because OBV is a leading indicator, which means it provides predictions, but it doesn’t offer much information regarding what has actually occurred in terms of the signals it sends.
Chaikin Money Flow vs. Money Flow Index
Another indicator that often gets compared with the CMF oscillator is the Money Flow Index (MFI). In simplest terms, MFI is a momentum indicator that gauges the flow of money into and out of a security.
However, the Money Flow Index is significantly different from the CMF since it utilizes volume and recent price action to measure momentum.
In many aspects, it resembles the Relative Strength Index (RSI). Normally, key levels to observe on the MFI are 80 and 20. If the index is higher than 80, it typically suggests that the market is overbought, and a drawdown could be expected. In contrast, if MFI falls below 20, it indicates that the market is oversold and that a rebound is likely. That said, buy and sell signals are generated only when the Money Flow Index surges beyond 80 or falls below 20.
Advantages and Disadvantages of the CMF Indicator
Just like any other technical indicator, the CMF also has its pros and cons that investors should be aware of.
One of its primary advantages is that it helps investors confirm a trend’s strength and its breakout direction. Furthermore, traders can clearly see the divergence between the security price and the CMF, allowing them to time their entry and exit moves.
Since it’s a momentum oscillator, the CMF is most efficient in trending markets, where it lets traders measure a trend’s strength and direction. When a trend’s strength fades, that loss is reflected in the CMF as divergence, suggesting that a trend reversal is imminent.
Among its key disadvantages is the risk of generating false signals. Like many other indicators, the CMF can occasionally generate fake signals, particularly if prices are volatile.
Also, since it is a lagging indicator that follows the price of a security, it is sometimes hard to time entries and exits perfectly with the CMF. As with any other indicator, Chaikin Money Flow is best used in conjunction with other technical indicators.
Conclusion
Chaikin Money Flow is a volume-weighted momentum indicator. Developed by Marc Chaikin in the early 1980s, the CMF aims to better understand the balance between accumulation (buying pressure) and distribution (selling pressure). When applying the CMF on a chart, areas above 0 represent net buying pressure, while below 0 readings show net selling pressure.
