Contents:Chaikin Money Flow Indicator is a technical analysis tool allowing binary options traders to measure the ratio between call- and put-options buyers within a given period. It was designed by a technical analyst and trader Mark Chaikin as a part of his technical indicators formula - Chaikin oscillator. A trading strategy based on Chaikin Money flow is based on a common rule of the technical analysis stating that all of the processes driving the market activity is already included in the price and the past period can be used to predict the future price action.
The balance between buyers of call and put options forms the supply/demand ratio, while the strength of price change depends on the volume and speed of cash flows from both sides.
What is Chaikin Money Flow?
Chaikin Money Flow Index consists of two parts: Money Flow Multiplier and Money Flow Volume plotted on a given period. The money flow multiplier reflects the difference between high, low and close prices of the underlying asset, while the money flow volume multiplies that result by the trading volume for the chosen period. As a result, the index floats between -1K and +1K, reflecting the buying pressure from the call and put options. Chaikin Money Flow is used as a standalone technical indicator to develop a binary options trading system as well as an additional tool to trade in conjunction with other technical instruments.
Chaikin Money Flow formula
Chaikin Money Flow formula is simple and reliable. Three iterations are required to calculate the final result. The money flow multiplier (MFM) is also used in the mathematical formula of Chaikin oscillator. The money flow volume is an adjusted value of trading volume for the chosen period multiplied by the MFM. Finally, the formula divides sums of both parameters for the given lookback period, which is the adjustable length of the indicator.
Here are all three iterations:
- Money flow multiplier (N) = [(Close - Low) - (High - Close)] / (High - Low);
- Money flow volume (M) = N * Volume (Period);
- Money Flow Index = SUM (period) of N / SUM (period) M.
What does the Chaikin Money Flow Index tell you?
The CMF indicator measures the change of ratio between the trading volume directed to buy call and put options, which reflects the recent momentum. If, for example, call option buyers step-in with heavy-volume buying pressure, then the underlying price reacts by charting consecutive higher highs. If that pressure continues and call-option buyers keep increasing the trading volume, then the uptrend accelerates. So when the CMF indicator is above the zero lines and ascending, it’s worth expecting prices to keep rising. Therefore, buying call options is preferable, implementing the trading approach of following trends.
On the other hand, when put-option buyers dominate, they constantly shift the ratio of the trading volume, increasing the selling pressure. The underlying asset price reacts by drawing consecutive lower lows on the chart. The CMF indicator reacts to that change by falling below the zero line and increasing the negative value. So when the CMF indicator is below zero and descending, binary options traders should consider pressing the put button in their trading cycles.
When the indicator peaked and started reversing the growth the positive territory, that could signal that the previous uptrend is getting exhausted and it’s worth expecting a rebound or consolidative sideways price action. Thus the trading cycle should be stopped or at least halted. Another important pattern occurs when the CMF indicator crosses the zero line, comes back to it from below or above but fails to cross it back. This occasion is called bounce-by-trend and it is used to increase the volume of trading deals in order to maximise profits.
How to use Chaikin Money Flow in binary options trading?
First of all, binary options traders should choose those underlying assets that deliver the maximum information about the trading volume and are liquid enough to reflect changes of the cashflow. For example, some of the exotic currency pairs have low trading volume and liquidity compared to major pairs. Thus any shifts of both parameters could lead to unpredictable changes in the exchange rate, while the technical indicator could not have a reaction that changes due to the lagging nature.
Second, traders should select timeframes that correspond to their individual trading strategies. A long-term chart would not give the appropriate information about the direction of trading binary options with a short expiry time, even though the CMF indicator would be in favour of bullish or bearish scenarios.
Third, the only parameter to adjust in Chaikin Money Flow Indicator is period or length. The most common period is 20 or 21 bars, but traders can adopt that value for their individual trading systems. They should remember that a too short period would take into account only the latest change of the money flows and ignore the nearest lookback period. So the sensitivity could be higher but the number of false signals could increase. A too long period, in contrast, would load unnecessary information from the past period, which does not influence present trading conditions anymore. Therefore, the CMF indicator would become too lagging and slow in terms of delivering profitable trading signals in time.
The rest of the trading rules is similar to ones of the Chaikin oscillator. The zero line divides the current technical sentiment on bullish and bearish. So when the CMF indicator is above zero and ascending, call options are expected to be in demand. Otherwise, if the CMF tool is negative, then put options could dominate.
Important signals are coming in together with crossovers. When the CMF index crosses the zero line from above, that signals a shift the ratio between the call- and put-option buyers, influencing the end of the previous downside price action and a start of a new uptrend. Failed tests of the zero line create so-called bounces, which indicates that the technical correction is getting exhausted and the previous trend is likely to continue moving prices in the same direction as before.
Chaikin Money Flow in combination with other technical indicators
Chaikin Money Flow can be used as a standalone technical instrument to deliver trading signals for a trading system. However, the best efficiency of a trading strategy is achieved when the CMF chart is powered by additional technical indicators measuring the trend’s momentum and/or reflecting oversold and overbought levels. Here are several examples of profitable trades using the Chaikin Money Flow indicator.
If you like this strategy, you might also be interested in this Keltner Channel
MACD, RSI and CMF
The MACD trend indicator can be applied as the primary tool to show the trend direction, fast and sensitive RSI oscillator could point to short-term price fluctuations, while the CMF index will confirm or deny trading signals coming in from others. The screenshot below shows the chart setup of MACD, RSI and CMF working together:
CMF and Chaikin oscillator
Both CMF and Chaikin Oscillator (CO) can empower each other’s advantages as well. For instance, three red arrows on the four-hourly chart of the GDP/AUD currency pair show a moment when a strong bearish trend started. Although the previous price action was heading north, the CMF indicator was hovering around the zero lines, signalling the ratio between the trading volume of call- and put-option buyers is not growing. That had to be used as a warning for binary options traders not to buy call options. On top of that, when the Chaikin oscillator peaked and started declining, traders could have begun a trading cycle of buying put options. The bullish scenario is shown on the right side of the chart. A sustainable uptrend started when both indicators crossed the zero line from below and increased the positive value.
ADX, Williams Fractals and CMF
This chart setup uses Williams fractals, a modified Average Directional Index with a period of 21 days and CMF with the same length. The screenshot below shows that Williams fractals deliver too many false trading signals and do not show strong trends. However, those fractals that appear together with a significant shift in the average directional index confirmed by the CMF indicators signal, can be rather lucrative in terms of showing periods when strong trends occur.
Chaikin Money Flow Index is a powerful technical tool to measure changes in the ratio of trading volume of call and put options buyers. Those cash flows create a buying pressure that drives the underlying asset prices. Therefore the trading strategy based on CMF indicator is profitable and efficient as it takes into account the main technical factor driving strong trends. However, additional technical indicators can be used in conjunction with CMF in order to increase the overall system’s efficiency and profitability, lower the number of fake signals and maximise profits from binary options trading.