The Chaikin Money Flow indicator, developed by Marc Chaikin, uses trading range, volume, and closing price to determine how much money is flowing into or out of a stock. “The formula emphasizes the fact that market strength is usually accompanied by prices closing in the upper half of their daily range with increasing volume. Likewise, market weakness is usually accompanied by prices closing in the lower half of their daily range with increasing volume.” (Martin J. Pring, Technical Analysis Explained, McGraw-Hill, Fourth Edition, page 422.)
Like other indicators, it can be used by stock traders to guide buy-sell decisions.
Chaikin Money Flow Based on Daily Stock Prices and Volume
Stock traders assume that when stock prices close in the top half of the range for the day, when the volume of the stock is increasing, this indicates buying pressure. Someone is putting money into this stock (or market), enough money so that the price ends the day fairly high relative to its range. If the stock does this for a number of days, clearly the stock is seeing some strength, even if the price is falling a little.
The Chaikin Money Flow uses a somewhat complicated formula that measures the difference between the daily close and the low, the daily high and the close, the range for the day, and the volume. This can be calculated for any number of trading periods. In fact, it can be used for intraday trading, with the “close” being the current price.
Traders, using charting software, can determine how many time periods to use with the Chaikin Money Flow indicator. Fifteen periods, typically days, seems to be a popular setting for this.
Interpreting the Chaikin Money Flow Indicator
The Chaikin Money Flow moves above and below zero. Above zero indicates strength in a stock (or market). Below zero indicates weakness. One way traders us this is to confirm a trend or a recent change in trend. The trend appears to be up? What does the Chaikin Money Flow say? If it isn’t moving up yet, you might want to wait to place that long trade.
Chaikin Money Flow can also be used, when it diverges from the current price trend, to signal an upcoming trend reversal. If the most recent high point in the Chaikin Money Flow is higher than the previous one, yet the stock price is still falling, this indicates money is flowing into the stock, and a trend reversal might soon occur.
Martin Pring says he likes to use this indicator “to study trading ranges, and then compare the price action to the oscillator to see if it is giving a clue as to the direction of the eventual breakout.” (Technical Analysis Explained, page 423) This description shows a clear understanding of the indicator, and time spent to see exactly what the indicator can tell about a stock’s current buying/selling pressure.
Traders don’t rely solely on Chaikin Money Flow for buy-sell decisions. Other indicators, and the stock price movement itself, must be viewed along with Chaikin Money Flow, to provide confirmation.
As with any trading tool or method, the trader is well advised to understand conduct his own research and use sound judgment to govern trading. Understand before you trade.
David A. Todd - David Todd is a civil engineer, a genealogist, a citizen concerned with the environment, and a writer by passion.
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