Chaikin Money Flow (CMF) Technical Indicator

Introduction

Developed by Marc Chaikin, the Chaikin Money Flow oscillator is calculated from the daily readings of the Accumulation/Distribution Line. The basic premise behind the Accumulation Distribution Line is that the degree of buying or selling pressure can be determined by the location of the Close relative to the High and Low for the corresponding period (Closing Location Value). There is buying pressure when a stock closes in the upper half of a period's range and there is selling pressure when a stock closes in the lower half of the period's trading range. The Closing Location Value multiplied by volume forms the Accumulation/Distribution Value for each period.

So, the Chaikin Money Flow is an indicator that is derived on the basis that a bullish stock will have a comparatively high closing price within its daily range and have increasing volume. If a security has consistently closed with a low closing price within its daily range with high volume, then this would be indicative of a weak security.

The best way to interpret the indicator is basically to adopt a positive or negative approach. If the oscillator is generating bullish signals then it is it going to be positive and is indicating that the security is being bought or accumulated. Conversely, if the oscillator is generating bearish signals then it is going to be negative and indicating the security is undergoing dispersion or distribution.

Methodology

The CIENA (CIEN) chart details the breakdown of the daily Accumulation/Distribution Values and how they relate to Chaikin Money Flow. The formula for Chaikin Money Flow is the cumulative total of the Accumulation/Distribution Values for 21 periods divided by the cumulative total of volume for 21 periods.

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On the CIENA chart, the purple box encloses 21 days of Accumulation/Distribution Values. The total of these 21 days divided by the total for the 21 days of volume forms the value of Chaikin Money Flow at the end of that day (purple arrow). To calculate the next day, the Accumulation/Distribution Value from the first day is removed and the value for the next day is entered into the equation.

The number of periods can be changed to suit a particular security and time frame. The 21-day Chaikin Money Flow is a good representation of the buying and selling pressure for the past month. A month is long enough to filter out the random noise. By using a longer time frame, the indicator will be less volatile and be less prone to whipsaws. For weekly and monthly charts, a shorter time frame is usually suitable.

Generally speaking, Chaikin Money Flow is bullish when it is positive and bearish when it is negative. The next item to assess is the range, the length of time Chaikin Money Flow has remained positive or negative. Even though divergences are not an intricate part of the strategy behind Chaikin Money Flow, the absolute level and the general direction of the oscillator can be important.

Accumulation Signals

  • The most obvious bullish signal that the Chaikin Money Flow can illustrate is when it is greater than zero. A reading of more than zero suggests that the security is under buying pressure or experiencing accumulation.
  • The amount of time that the Chaikin Money Flow has remained greater than zero is also another important feature of the indicator. Basically, the longer it remains positive, then the greater the probability that the security will continue to be pressured by buyers, which will in turn prolong its rise.
  • Remember – the more positive the indicator is, the more evidence there is of increase buying pressure which should be reflected in the price.
Dispersion Signals

  • The most obvious bearish signal that the Chaikin Money Flow can illustrate is when it is less than zero. A reading of less than zero suggests that the security is under selling pressure or experiencing dispersion.
  • The amount of time that the Chaikin Money Flow has remained less than zero is also another important feature of the indicator. Basically, the longer it remains negative, then the greater the probability that the security will continue to be pressured by sellers, which will in turn prolong its fall.
  • Marc Chaikin also specified that in order to fully comprehend the indicator the level or degree to which dispersion of a security occurred was vital to fully understanding the power of the indicator itself. He considered a reading below -0.25 to suggest that the security was under strong selling pressure and a reading above +0.25 to be indicative of strong buying pressure. This relatively large level has been open to some criticism in the Technical Trading community and most Traders now prefer to use readings of ±0.10.
Trading Strategies

The more positive the indicator is, the more evidence there is of increased buying pressure which should be reflected in the price of the security. Converesly, the more negative the indicator is, the more evidence there is of increased selling pressure which should be reflected in the price of the security. This should suggest that you should:
  • Go long if price has broken above a resistance band and is confirmed by a positive Chaikin Money Flow figure.
  • Go short if price has broken below a support band and is confirmed by a negative Chaikin Money Flow figure.
The main other strategies revolve around Multiple Indicator Confirmation. A good set of indicators that do not complement one other are:
  • Chaikin Money Flow
  • RSI – Momentum indicator providing absolute levels of overbought and oversold
  • Moving Averages – Trend-following, or lagging indicator that attempts to identify trend changes in securities.
Weaknesses

The problems with the Chaikin Money Flow indicator extend two-fold:
  • Firstly, because the indicator does not account for Breakouts or Gaps and,
  • Secondly because abnormal data patterns effect the calculation of the indicator.
Thus, the indicator is unlike a momentum oscillator and is therefore not influenced by a daily changing price average. Rather the indicator measures the location of the closing price relative to the range for the period – whatever this may be. While some argue that this is a definitive strength of the indicator, many inexperienced traders can vouch that it is also one of its greatest weaknesses.

Normal Formula:

Price is multiplied by the volume and added to the momentum from the previous day. Volume is used to indicate how much of the market was supporting the price change.
It subtracts a 10-day exponential moving average of the Accumulation/Distribution indicator from a 3-day exponential moving average of that same value. As the indicator uses exponential moving averages there will be data present at the beginning of the series. These figures are usually ignored as they do not add any value to the indicator itself.

Typical Charting Program Formula:

D :=(HIGH-LOW);
AD:=IF(D==0,0,((CLOSE-LOW)-(HIGH-CLOSE))/D*VOL);
MV :=MA(VOL,N);
CMF:IF(MV==0,0,MA(AD,N)/MV),COLORSTICK;

Formula Parameters:

- Name: N
- Default Value: 20
- Minimum Value: 1
- Maximum Value: 100

Sources and Additional Information:

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