- Chaikin Money Flow is a technical indicator used to analyse the stock market.
- It measures the accumulation-distribution line of moving average convergence-divergence (MACD), using price and volume traded as the inputs.
Formula for Chaikin Money Flow Indicator:
- N = ((close – low) – (high – close))/(high – low)
- M = N * volume(period)
- Accumulation-Distribution Line (ADL) = M(period-1) + M(period)
- CMF = (3-day EMA of ADL) – (10-day EMA of ADL)
- N = money flow multiplier;
- M= money flow volume;
- CMF = Chaikin Money Flow indicator;
- EMA = Exponential Moving Average;
- The Chaikin money flow indicator is mainly used to identify the underlying momentum during price fluctuations in accumulation-distribution.
- Whenever a positive divergence is observed along with the CMF indicator crossing above the ADL (dotted line in the image), it indicates a potential buy signal.
- Existing traders can exit their long positions and initiate long unwinding. New traders can enter the market and initiate their short positions.
- Similarly, whenever a negative divergence is observed along with the CMF indicator crossing below the ADL (dotted line in the image), it indicates a potential sell signal.
- Existing traders can exit their short positions and initiate short covering. New traders can enter the market and initiate their long positions.
This is the 1 day chart of Infosys Ltd around Jan-Aug, 2020
The dotted line indicates ADL line
- A positive divergence indicates that the stock price rises, given that accumulation increases. Similarly, a negative divergence indicates that the stock price falls, given that distribution increases.
- The main disadvantage of this indicator is that it is difficult to use because of its complexity and many calculations. Inexperienced traders might take false signals from the indicator and fall into losses.
- Hence, traders should gain experience from sample trades before using this indicator.