Updated: Feb 1, 2022
If you need to understand the price action of cryptocurrency, you need to know about money flow first. A broad focus of any student of the technical analysis is to keenly study the indicators which allow investors to make sharper entry points and exit points in their trading program.
You will understand the money flow developed by Marc Chaikin, which uses price and volume to record a complete picture of the price action of the particular issue.
So, what is money flow?
Money flow is calculated by averaging the high, low, and closing prices and then multiplying by the daily volume. Comparing these results with the number of the previous day will tell the traders whether money flow is positive or negative for the present day.
It is an indexed value based on volume and price for several bars specified in the input length. The positive money flow is also calculated and summed for every last length of bars having an average price greater than the previous bar and then divided by Money Flow for all bars specified in length.
The use of price and volume gives a different perspective from the volume or price alone. The Money Flow indicator also tends to show dramatic oscillations and may be useful in identifying oversold and overbought conditions.
Positive money flow shows that prices will likely grow higher, while negative money flow shows that prices will fall. Now let us break up the money flow for you:
How does money flow work:
To understand the working of money flow, we will have to break it up in an easy language. The first thing is to fully explain distribution and accumulation, as it is the momentum indicator that determines money flow.
Chaikin found an understanding that if the stock closed over its midpoint for the given session, the stock showed accumulation that day. On the opposite, the distribution is an order of the day if a stock is closed under the midpoint
The breaking of money flow:
Positive money flow happens when the stock is bought at a higher price. Negative money flow happens when the next trade is bought at a lower price. If more of the shares were bought in a day over the uptick than the downtick, net money flow is then positive because more and more investors were keen to pay a premium for the overall stock.
If money flow is negative when the stock price rises, this may show a pending price reversal. Investors also monitor the money flow as trading volume is mostly considered to lead price, which may help identify early trading opportunities.
Money flow and the money flow indicators:
You need to understand these and know about the flow of money in cryptocurrency. Most traders use a Chaikin money flow oscillator when they are willing to incorporate money flow in their trading decisions. The indicators created by Marc Chaikin produce a value for selling and buying pressure like the other money flow indicators and use two exponentials moving averages in determining momentum in a similar way as the moving average convergence divergence indicator shows.
Traders also use the money flow index when they are willing to analyze volume and price. This indicator then divides the net positive flow of money by the net negative money flow and then plots the value as a line which traders can create a comparison with to a price of security in identifying overbought and oversold levels. If an indicator is above 80, prices are thought of as overbought. A value under 20 shows oversold conditions.
The other technical indicators must be used in conjunction with the money flow indicators to improve their effectiveness and reduce false trading signs. The same is the flow of money in cryptocurrency.
A few words of caution:
It is very important to consider the other indicators that support your entry and exit points in trading - confluence. And also, note that spiky tops mostly show that money flow is about to top out. Furthermore, gaps in price action might show another problem you must be aware of: we also determine the money flow by calculating the price action's midpoint. But if larger gaps happen, then the midpoint is missing, and money flow numbers are also skewed.
This is a simple look at a complex indicator. Although money flow might be excellent for identifying the oversold and overbought positions, its dependency on accumulation and distribution might distort its total numbers if the midpoint is missing out. Always remember to use the signals of other indicators and their confluence to verify the entry and exit points.
When you understand how the flow of money in cryptocurrency works, you will also get the hang of making more profits by making the right move at the right time.