Technical indicators

Technical indicators are heuristic or mathematical calculations based on

the price, volume, or open interest of a security or contract used by
traders who follow technical analysis.
Technical analysts or chartists look for technical indicators in historical
asset price data to judge entry and exit points for trades.
There are several technical indicators that fall broadly into two main
categories: overlays and oscillators.
How Technical Indicators Work
Technical analysis is a trading discipline employed to evaluate
investments and identify trading opportunities by analyzing statistical
trends gathered from trading activity, such as price movement and
volume. Unlike fundamental analysts, who attempt to evaluate a
security’s intrinsic value based on financial or economic data, technical
analysts focus on patterns of price movements, trading signals, and
various other analytical charting tools to evaluate a security’s strength
or weakness.
Technical analysis can be used on any security with historical trading
data. This includes stocks, futures, commodities, fixed-income,
currencies, and other securities.
Technical indicators, also known as “technicals,” are focused on
historical trading data, such as price, volume, and open interest, rather
than the fundamentals of a business, such as earnings, revenue, or
profit margins. Technical indicators are commonly used by active
traders, since they’re designed to analyze short-term price movements,
but long-term investors may also use technical indicators to identify
entry and exit points.
Types of Indicators
There are two basic types of technical indicators:
Overlays: Technical indicators that use the same scale as prices are
plotted over the top of the prices on a stock chart. Examples include
moving averages and Bollinger Bands®.
Oscillators: Technical indicators that oscillate between a local minimum
and maximum are plotted above or below a price chart. Examples
include the stochastic oscillator, MACD, or RSI.
Traders often use many different technical indicators when analyzing a
security. With thousands of different options, traders must choose the
indicators that work best for them and familiarize themselves with how
they work. Traders may also combine technical indicators with more
subjective forms of technical analysis, such as looking at chart patterns,
to come up with trade ideas. Technical indicators can also be
incorporated into automated trading systems, given their quantitative
nature.
Oscillators
An oscillator is a technical analysis tool that constructs high and low
bands between two extreme values, and then builds a trend indicator
that fluctuates within these bounds. Traders use the trend indicator to
discover short-term overbought or oversold conditions. When the value
of the oscillator approaches the upper extreme value, technical analysts
interpret that information to mean that the asset is overbought, and as
it approaches the lower extreme, technicians consider the asset to be
oversold.
How Oscillators Work
Oscillators are typically used in conjunction with other technical
analysis indicators to make trading decisions. Analysts find oscillators
most advantageous when they cannot find a clear trend in a company's
stock price easily, for example when a stock trades horizontally or
sideways. The most common oscillators are the stochastic oscillator,
relative strength (RSI), rate of change (ROC), and money flow (MFI). In
technical analysis, investors find oscillators to be one of the most
important technical tools to understand, but there are also other
technical tools that analysts find helpful in enhancing their trading, such
as chart reading skills and the technical indicators.
If an investor uses an oscillator, they first pick two values; then, placing
the tool between the two, the oscillator oscillates, creating a trend
indicator. Investors then use the trend indicator to read current market
conditions for that particular asset. When the investor sees that the
oscillator moves toward the higher value, the investor reads the asset
as overbought. In the opposite scenario, when the oscillator trends
towards the lower value, the investors consider the asset oversold.
Mechanics of an Oscillator
In technical analysis, an investor measures oscillators on a percentage
scale from 0 to 100, where the closing price is relative to the total price
range for a specified number of bars in a given bar chart. In order to
achieve this, one deploys various techniques of manipulating and
smoothing out multiple moving averages. When the market trades in a
specific range, the oscillator follows the price fluctuations and indicates
an overbought condition when it exceeds 70 to 80% of the specified
total price range, signifying a sell opportunity. An oversold condition
exists when the oscillator falls below 30 to 20%, which signifies a buy
opportunity.
The signals remain valid as long as the price of the underlying security
remains in the established range. However, when a price breakout
occurs, the signals may be misleading. Analysts consider a price
breakout either the resetting of the range by which the current
sideways market is bound or the beginning of a new trend. During the
price breakout, the oscillator may remain in the overbought or oversold
range for an extended period of time.
Technical analysts consider oscillators better suited for sideways
markets and consider them more effective when used in conjunction
with a technical indicator that identifies the market as being in a trend
or range-bound. For example, a moving average crossover indicator can
be used to determine if a market is, or is not, in a trend. Once the
analysts determine that the market is not in a trend, the signals of an
oscillator become much more useful and effective.

Examples of common technical indicators include the

 Relative Strength Index (RSI),
 Money Flow Index (MFI),
 stochastics,
 moving average convergence divergence (MACD), and
 Bollinger Bands.
What Is the Relative Strength Index (RSI)?
The relative strength index (RSI) is a momentum indicator used in
technical analysis that measures the magnitude of recent price changes
to evaluate overbought or oversold conditions in the price of a stock or
other asset. The RSI is displayed as an oscillator (a line graph that
moves between two extremes) and can have a reading from 0 to 100.
The indicator was originally developed by J. Welles Wilder Jr. and
introduced in his seminal 1978 book, “New Concepts in Technical
Trading Systems.”

Traditional interpretation and usage of the RSI are that values of 70 or

above indicate that a security is becoming overbought or overvalued
and may be primed for a trend reversal or corrective pullback in price.
An RSI reading of 30 or below indicates an oversold or undervalued
condition.

KEY TAKEAWAYS
The relative strength index (RSI) is a popular momentum oscillator
developed in 1978.
The RSI provides technical traders with signals about bullish and bearish
price momentum, and it is often plotted beneath the graph of an
asset’s price.
An asset is usually considered overbought when the RSI is above 70%
and oversold when it is below 30%.
Using the formulas above, the RSI can be calculated, where the RSI line
can then be plotted beneath an asset’s price chart.
The RSI will rise as the number and size of positive closes increase, and
it will fall as the number and size of losses increase. The second part of
the calculation smooths the result, so the RSI will only near 100 or 0 in a
strongly trending market.
As you can see in the above chart, the RSI indicator can stay in the
overbought region for extended periods while the stock is in an
uptrend. The indicator may also remain in oversold territory for a long
time when the stock is in a downtrend. This can be confusing for new
analysts, but learning to use the indicator within the context of the
prevailing trend will clarify these issues.
what Does the RSI Tell You?
The primary trend of the stock or asset is an important tool in making
sure the indicator’s readings are properly understood. For example,
well-known market technician Constance Brown, CMT, has promoted
the idea that an oversold reading on the RSI in an uptrend is likely much
higher than 30% and that an overbought reading on the RSI during a
downtrend is much lower than the 70% level.1
As you can see in the following chart, during a downtrend, the RSI
would peak near the 50% level rather than 70%, which could be used by
investors to more reliably signal bearish conditions. Many investors will
apply a horizontal trendline between 30% and 70% levels when a strong
trend is in place to better identify extremes. Modifying overbought or
oversold levels when the price of a stock or asset is in a long-term
horizontal channel is usually unnecessary.
A related concept to using overbought or oversold levels appropriate to
the trend is to focus on trade signals and techniques that conform to
the trend. In other words, using bullish signals when the price is in a
bullish trend and bearish signals when a stock is in a bearish trend will
help to avoid the many false alarms that the RSI can generate.
Interpretation of RSI and RSI Ranges
Generally, when the RSI surpasses the horizontal 30 reference level, it is
a bullish sign, and when it slides below the horizontal 70 reference
level, it is a bearish sign. Put another way, one can interpret that RSI
values of 70 or above indicate a security is becoming overbought or
overvalued and may be primed for a trend reversal or corrective price
pullback. An RSI reading of 30 or below indicates an oversold or
undervalued condition.
During trends, the RSI readings may fall into a band or range. During an
uptrend, the RSI tends to stay above 30 and should frequently hit 70.
During a downtrend, it is rare to see the RSI exceed 70, and the
indicator frequently hits 30 or below. These guidelines can help
determine trend strength and spot potential reversals. For example, if
the RSI can’t reach 70 on a number of consecutive price swings during
an uptrend, but then drops below 30, the trend has weakened and
could be reversing lower.
The opposite is true for a downtrend. If the downtrend is unable to
reach 30 or below and then rallies above 70, that downtrend has
weakened and could be reversing to the upside. Trend lines and moving
averages are helpful tools to include when using the RSI in this way.
The Difference Between RSI and MACD
The moving average convergence divergence (MACD) is another trend-
following momentum indicator that shows the relationship between
two moving averages of a security’s price. The MACD is calculated by
subtracting the 26-period exponential moving average (EMA) from the
12-period EMA. The result of that calculation is the MACD line.
A nine-day EMA of the MACD, called the “signal line,” is then plotted on
top of the MACD line, which can function as a trigger for buy and sell
signals. Traders may buy the security when the MACD crosses above its
signal line and sell, or short, the security when the MACD crosses below
the signal line.
The RSI was designed to indicate whether a security is overbought or
oversold in relation to recent price levels. The RSI is calculated using
average price gains and losses over a given period of time. The default
time period is 14 periods, with values bounded from 0 to 100.

The MACD measures the relationship between two EMAs, while the RSI
measures price change in relation to recent price highs and lows. These
two indicators are often used together to provide analysts with a more
complete technical picture of a market.
These indicators both measure the momentum of an asset. However,
they measure different factors, so they sometimes give contradictory
indications. For example, the RSI may show a reading above 70 for a
sustained period of time, indicating the security is overextended to the
buy side.
At the same time, the MACD could indicate that buying momentum is
still increasing for the security. Either indicator may signal an upcoming
trend change by showing divergence from price (the price continues
higher while the indicator turns lower, or vice versa).
Limitations of the RSI
The RSI compares bullish and bearish price momentum and displays the
results in an oscillator that can be placed beneath a price chart. Like
most technical indicators, its signals are most reliable when they
conform to the long-term trend.
True reversal signals are rare and can be difficult to separate from false
alarms. A false positive, for example, would be a bullish crossover
followed by a sudden decline in a stock. A false negative would be a
situation where there is a bearish crossover, yet the stock suddenly
accelerated upward.
Since the indicator displays momentum, it can stay overbought or
oversold for a long time when an asset has significant momentum in
either direction. Therefore, the RSI is most useful in an oscillating
market where the asset price is alternating between bullish and bearish
movements.

What Is a Stochastic Oscillator?

A stochastic oscillator is a momentum indicator comparing a particular
closing price of a security to a range of its prices over a certain period of
time. The sensitivity of the oscillator to market movements is reducible
by adjusting that time period or by taking a moving average of the
result. It is used to generate overbought and oversold trading signals,
utilizing a 0–100 bounded range of values.
A stochastic oscillator is a popular technical indicator for generating
overbought and oversold signals.
It is a popular momentum indicator, first developed in the 1950s.
Stochastic oscillators tend to vary around some mean price level, since
they rely on an asset's price history.
The general theory serving as the foundation for this indicator is that in
a market trending upward, prices will close near the high, and in a
market trending downward, prices close near the low. Transaction
signals are created when the %K crosses through a three-period moving
average, which is called the %D.
The difference between the slow and fast Stochastic Oscillator is the
Slow %K incorporates a %K slowing period of 3 that controls the
internal smoothing of %K. Setting the smoothing period to 1 is
equivalent to plotting the Fast Stochastic Oscillator.1

What Does the Stochastic Oscillator Tell You?

The stochastic oscillator is range-bound, meaning it is always between 0
and 100. This makes it a useful indicator of overbought and oversold
conditions. Traditionally, readings over 80 are considered in the
overbought range, and readings under 20 are considered oversold.
However, these are not always indicative of impending reversal; very
strong trends can maintain overbought or oversold conditions for an
extended period. Instead, traders should look to changes in the
stochastic oscillator for clues about future trend shifts.

Stochastic oscillator charting generally consists of two lines: one

reflecting the actual value of the oscillator for each session, and one
reflecting its three-day simple moving average. Because price is thought
to follow momentum, the intersection of these two lines is considered
to be a signal that a reversal may be in the works, as it indicates a large
shift in momentum from day to day.

Divergence between the stochastic oscillator and trending price action

is also seen as an important reversal signal. For example, when a
bearish trend reaches a new lower low, but the oscillator prints a
higher low, it may be an indicator that bears are exhausting their
momentum and a bullish reversal is brewing.
The Difference Between The Relative Strength Index (RSI) and The
Stochastic Oscillator
The relative strength index (RSI) and stochastic oscillator are both price
momentum oscillators that are widely used in technical analysis. While
often used in tandem, they each have different underlying theories and
methods. The stochastic oscillator is predicated on the assumption that
closing prices should close near the same direction as the current trend.

Meanwhile, the RSI tracks overbought and oversold levels by measuring

the velocity of price movements. In other words, the RSI was designed
to measure the speed of price movements, while the stochastic
oscillator formula works best in consistent trading ranges.

In general, the RSI is more useful during trending markets, and

stochastics more so in sideways or choppy markets.

Limitations of the Stochastic Oscillator

The primary limitation of the stochastic oscillator is that it has been
known to produce false signals. This is when a trading signal is
generated by the indicator, yet the price does not actually follow
through, which can end up as a losing trade. During volatile market
conditions, this can happen quite regularly. One way to help with this is
to take the price trend as a filter, where signals are only taken if they
are in the same direction as the trend.
What Is Moving Average Convergence Divergence (MACD)?
Moving average convergence divergence (MACD) is a trend-following
momentum indicator that shows the relationship between two moving
averages of a security’s price. The MACD is calculated by subtracting
the 26-period exponential moving average (EMA) from the 12-period
EMA.

The result of that calculation is the MACD line. A nine-day EMA of the
MACD called the "signal line," is then plotted on top of the MACD line,
which can function as a trigger for buy and sell signals. Traders may buy
the security when the MACD crosses above its signal line and sell—or
short—the security when the MACD crosses below the signal line.
Moving average convergence divergence (MACD) indicators can be
interpreted in several ways, but the more common methods are
crossovers, divergences, and rapid rises/falls.

KEY TAKEAWAYS
Moving average convergence divergence (MACD) is calculated by
subtracting the 26-period exponential moving average (EMA) from the
12-period EMA.
MACD triggers technical signals when it crosses above (to buy) or below
(to sell) its signal line.
The speed of crossovers is also taken as a signal of a market is
overbought or oversold.
MACD helps investors understand whether the bullish or bearish
movement in the price is strengthening or weakening.
Learning From MACD
The MACD has a positive value (shown as the blue line in the lower
chart) whenever the 12-period EMA (indicated by the red line on the
price chart) is above the 26-period EMA (the blue line in the price chart)
and a negative value when the 12-period EMA is below the 26-period
EMA. The more distant the MACD is above or below its baseline
indicates that the distance between the two EMAs is growing.

In the following chart, you can see how the two EMAs applied to the
price chart correspond to the MACD (blue) crossing above or below its
baseline (dashed) in the indicator below the price chart.

Image
Image by Sabrina Jiang © Investopedia 2020
MACD is often displayed with a histogram (see the chart below) which
graphs the distance between the MACD and its signal line. If the MACD
is above the signal line, the histogram will be above the MACD’s
baseline. If the MACD is below its signal line, the histogram will be
below the MACD’s baseline. Traders use the MACD’s histogram to
identify when bullish or bearish momentum is high.
MACD vs. Relative Strength
The relative strength indicator (RSI) aims to signal whether a market is
considered to be overbought or oversold in relation to recent price
levels. The RSI is an oscillator that calculates average price gains and
losses over a given period of time. The default time period is 14 periods
with values bounded from 0 to 100.

MACD measures the relationship between two EMAs, while the RSI
measures price change in relation to recent price highs and lows. These
two indicators are often used together to provide analysts a more
complete technical picture of a market.

These indicators both measure momentum in a market, but, because

they measure different factors, they sometimes give contrary
indications. For example, the RSI may show a reading above 70 for a
sustained period of time, indicating a market is overextended to the
buy side in relation to recent prices, while the MACD indicates the
market is still increasing in buying momentum. Either indicator may
signal an upcoming trend change by showing divergence from price
(price continues higher while the indicator turns lower, or vice versa).

Limitations of MACD
One of the main problems with divergence is that it can often signal a
possible reversal but then no actual reversal actually happens—it
produces a false positive. The other problem is that divergence doesn't
forecast all reversals. In other words, it predicts too many reversals that
don't occur and not enough real price reversals.
"False positive" divergence often occurs when the price of an asset
moves sideways, such as in a range or triangle pattern following a
trend. A slowdown in the momentum—sideways movement or slow
trending movement—of the price will cause the MACD to pull away
from its prior extremes and gravitate toward the zero lines even in the
absence of a true reversal.
Is MACD a Leading Indicator, or a Lagging Indicator?
MACD is a lagging indicator. After all, all of the data used in MACD is
based on the historical price action of the stock. Since it is based on
historical data, it must necessarily “lag” the price. However, some
traders use MACD histograms to predict when a change in trend will
occur. For these traders, this aspect of the MACD might be viewed as a
leading indicator of future trend changes.
What Is a MACD Positive Divergence?
A MACD positive divergence is a situation in which the MACD does not
reach a new low, despite the fact that the price of the stock reached a
new low. This is seen as a bullish trading signal—hence, the term
“positive divergence.” If the opposite scenario occurs—the stock price
reaching a new high, but the MACD failing to do so—this would be seen
as a bearish indicator and referred to as a negative divergence.

What Is a Bollinger Band®?

A Bollinger Band® is a technical analysis tool defined by a set of
trendlines plotted two standard deviations (positively and negatively)
away from a simple moving average (SMA) of a security's price, but
which can be adjusted to user preferences.
Bollinger Bands® were developed and copyrighted by famous technical
trader John Bollinger, designed to discover opportunities that give
investors a higher probability of properly identifying when an asset is
oversold or overbought.1

KEY TAKEAWAYS
Bollinger Bands® are a technical analysis tool developed by John
Bollinger for generating oversold or overbought signals.
There are three lines that compose Bollinger Bands: A simple moving
average (middle band) and an upper and lower band.
The upper and lower bands are typically 2 standard deviations +/- from
a 20-day simple moving average, but can be modified.
How To Calculate Bollinger Bands®
The first step in calculating Bollinger Bands® is to compute the simple
moving average of the security in question, typically using a 20-day
SMA. A 20-day moving average would average out the closing prices for
the first 20 days as the first data point. The next data point would drop
the earliest price, add the price on day 21 and take the average, and so
on. Next, the standard deviation of the security's price will be obtained.
Standard deviation is a mathematical measurement of average variance
and features prominently in statistics, economics, accounting and
finance.
For a given data set, the standard deviation measures how spread out
numbers are from an average value. Standard deviation can be
calculated by taking the square root of the variance, which itself is the
average of the squared differences of the mean. Next, multiply that
standard deviation value by two and both add and subtract that
amount from each point along the SMA. Those produce the upper and
lower bands
What Do Bollinger Bands® Tell You?
Bollinger Bands® are a highly popular technique. Many traders believe
the closer the prices move to the upper band, the more overbought the
market, and the closer the prices move to the lower band, the more
oversold the market. John Bollinger has a set of 22 rules to follow when
using the bands as a trading system.2

In the chart depicted below, Bollinger Bands® bracket the 20-day SMA
of the stock with an upper and lower band along with the daily
movements of the stock's price. Because standard deviation is a
measure of volatility, when the markets become more volatile the
bands widen; during less volatile periods, the bands contract.

Image
Image by Sabrina Jiang © Investopedia 2021

The Squeeze
The squeeze is the central concept of Bollinger Bands®. When the
bands come close together, constricting the moving average, it is called
a squeeze. A squeeze signals a period of low volatility and is considered
by traders to be a potential sign of future increased volatility and
possible trading opportunities. Conversely, the wider apart the bands
move, the more likely the chance of a decrease in volatility and the
greater the possibility of exiting a trade. However, these conditions are
not trading signals. The bands give no indication when the change may
take place or which direction price could move.

Breakouts
Approximately 90% of price action occurs between the two bands. Any
breakout above or below the bands is a major event. The breakout is
not a trading signal. The mistake most people make is believing that
that price hitting or exceeding one of the bands is a signal to buy or sell.
Breakouts provide no clue as to the direction and extent of future price
movement.

Limitations of Bollinger Bands®

Bollinger Bands® are not a standalone trading system. They are simply
one indicator designed to provide traders with information regarding
price volatility. John Bollinger suggests using them with two or three
other non-correlated indicators that provide more direct market
signals. He believes it is crucial to use indicators based on different
types of data. Some of his favored technical techniques are moving
average divergence/convergence (MACD), on-balance volume and
relative strength index (RSI).
Because they are computed from a simple moving average, they weight
older price data the same as the most recent, meaning that new
information may be diluted by outdated data. Also, the use of 20-day
SMA and 2 standard deviations is a bit arbitrary and may not work for
everyone in every situation. Traders should adjust their SMA and
standard deviation assumptions accordingly and monitor them.
What Is the Money Flow Index (MFI)?
The Money Flow Index (MFI) is a technical oscillator that uses price and
volume data for identifying overbought or oversold signals in an asset.
It can also be used to spot divergences which warn of a trend change in
price. The oscillator moves between 0 and 100.

Unlike conventional oscillators such as the Relative Strength Index (RSI),

the Money Flow Index incorporates both price and volume data, as
opposed to just price. For this reason, some analysts call MFI the
volume-weighted RSI.

KEY TAKEAWAYS
The Money Flow Index (MFI) is a technical indicator that generates
overbought or oversold signals using both prices and volume data.
An MFI reading above 80 is considered overbought and an MFI reading
below 20 is considered oversold, although levels of 90 and 10 are also
used as thresholds.
A divergence between the indicator and price is noteworthy. For
example, if the indicator is rising while the price is falling or flat, the
price could start rising.
Image
Image by Sabrina Jiang © Investopedia 2021

The Formulas for the Money Flow Index Are:

\begin{aligned} &\text{Money Flow Index}=100-\frac{100}
{1+\text{Money Flow Ratio}}\\ &\textbf{where:}\\ &\text{Money Flow
Ratio}=\frac{\text{14 Period Positive Money Flow}}{\text{14 Period
Negative Money Flow}}\\ &\text{Raw Money Flow}=\text{Typical Price
* Volume}\\ &\text{Typical Price}=\frac{\text{High + Low + Close}}
{3}\\ \end{aligned}

Money Flow Index=100−

1+Money Flow Ratio
100

where:
Money Flow Ratio=
14 Period Negative Money Flow
14 Period Positive Money Flow
Raw Money Flow=Typical Price * Volume
Typical Price=
3
High + Low + Close

When the price advances from one period to the next Raw Money Flow
is positive and it is added to Positive Money Flow. When Raw Money
Flow is negative because the price dropped that period, it is added to
Negative Money Flow.

How to Calculate the Money Flow Index

There are several steps for calculating the Money Flow Index. If doing it
by hand, using a spreadsheet is recommended.
Calculate the Typical Price for each of the last 14 periods.
For each period, mark whether the typical price was higher or lower
than the prior period. This will tell you whether Raw Money Flow is
positive or negative.
Calculate Raw Money Flow by multiplying the Typical Price by Volume
for that period. Use negative or positive numbers depending on
whether the period was up or down (see step above).
Calculate the Money Flow Ratio by adding up all the positive money
flows over the last 14 periods and dividing it by the negative money
flows for the last 14 periods.
Calculate the Money Flow Index (MFI) using the ratio found in step
four.
Continue doing the calculations as each new period ends, using only the
last 14 periods of data.

What Does the Money Flow Index Tell You?

One of the primary ways to use the Money Flow Index is when there is
a divergence. A divergence is when the oscillator is moving in the
opposite direction of price. This is a signal of a potential reversal in the
prevailing price trend.

For example, a very high Money Flow Index that begins to fall below a
reading of 80 while the underlying security continues to climb is a price
reversal signal to the downside. Conversely, a very low MFI reading that
climbs above a reading of 20 while the underlying security continues to
sell off is a price reversal signal to the upside.
Traders also watch for larger divergences using multiple waves in the
price and MFI. For example, a stock peaks at $10, pulls back to $8, and
then rallies to $12. The price has made two successive highs, at $10 and
$12. If MFI makes a lower higher when the price reaches $12, the
indicator is not confirming the new high. This could foreshadow a
decline in price.

The overbought and oversold levels are also used to signal possible
trading opportunities. Moves below 10 and above 90 are rare. Traders
watch for the MFI to move back above 10 to signal a long trade, and to
drop below 90 to signal a short trade.

Other moves out of overbought or oversold territory can also be useful.

For example, when an asset is in an uptrend, a drop below 20 (or even
30) and then a rally back above it could indicate a pullback is over and
the price uptrend is resuming. The same goes for a downtrend. A short-
term rally could push the MFI up to 70 or 80, but when it drops back
below that could be the time to enter a short trade in preparation for
another drop.

The Difference Between the Money Flow Index and the Relative
Strength Index (RSI)
The MFI and RSI are very closely related. The main difference is that
MFI incorporates volume, while the RSI does not. Proponents of volume
analysis believe it is a leading indicator. Therefore, they also believe
that MFI will provide signals, and warn of possible reversals, in a more
timely fashion than the RSI. One indicator is not better than the other,
they are simply incorporating different elements and will, therefore,
provide signals at different times.

Limitations of the Money Flow Index

The MFI is capable of producing false signals. This is when the indicator
does something that indicates a good trading opportunity is present,
but then the price doesn't move as expected resulting in a losing trade.
A divergence may not result in a price reversal, for instance.

The indicator may also fail to warn of something important. For

example, while a divergence may result in a price reversing some of the
time, divergence won't be present for all price reversals. Because of
this, it is recommended that traders use other forms of analysis and risk
control and not rely exclusively on one indicator.