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What is Money Flow?
A very powerful indicator for where a stock’s price is heading is whether institutional investors are buying or selling. After all, a stock’s price is only worth what another investor is willing to pay.
Thankfully, one of the analytics tools that comes with your StockTrak account makes it easy to see where money is flowing – this is called Chaikin Money Flow.
The “Chaikin Money Flow” metric is a technical analysis tool developed in the 1980’s by Marc Chaikin to measure buying pressure vs. selling pressure over time. From a trader’s point of view, it’s deceptively simple – green and high when there’s buying pressure, red and low when there’s selling pressure.
The formula for the daily Chaikin Money Flow value is:
The value ranges from +100 to -100, reflecting a stock’s volume-weighted closing performance over a one month (21-day) period.
Because of the way the calculation was designed, money flow persistency (significant regions of green or red over a 6-9 month period), can be signs of accumulation or distribution by major institutions which have a disproportionate effect on future price movement. This is true even though the calculation looks only at price/volume activity, rather than directly monitoring institutional order flow.
If you are just doing cursory research before you buy a stock, you can use Chaikin Money Flow in the same way as the Chaikin Power Gauge. Long periods of green usually imply the stock is looking at price increases, while if you’re deep in a red stretch you might want to check back later. Just looking at Chaikin Money Flow alone isn’t as powerful as the Chaikin Power Gauge, but if the two are pointing in the same direction, it is a stronger sign than if not.
Why Does This Work?
The “Buying Pressure” that Chaikin Money Flow measures is based on how close a stock’s price closes compared with its high for the day, and weighted by volume. If the stock consistently has significant volume and is closing high, it is a strong sign that institutional investors, including ETF and Mutual Fund managers, are buying it up as part of growth portfolios. The opposite is also true – even if a stock’s price is not dropping, if the closing prices are consistently pushing towards the lower end of the day’s trading range, it is a sign that institutions are starting to offload it from their portfolios.
Money Flow Divergence
You can use the Chaikin Money Flow indicator to try to measure your risk when examining a potential stock buy that is rebounding from a drop. Picking up a stock near its price floor to ride the recovery can be a great way to make profits on trades, but without some technical analysis you could be trying to catch a falling knife – more likely to get cut than anything else. The “Money Flow Divergence” is when the stock’s price movement and its Money Flow indicator don’t agree. For example, a “negative” divergence is when a stock’s price looks like it’s going back up, but the money flow still looks negative. This should be a red flag for your trades – if the price is trending up, but still closing well below each day’s trading highs, it could point to most of the upward movement coming from individual traders trying to pick it up on the rebound, and a big short-term risk. If the price and Money Flow both start looking positive, though, it is a confirmation signal. As Chaikin Money Flow starts turning green and the price goes up, it shows that there is real momentum in the market pointing towards price recovery.