Trading Crash Course | Understanding how the Chaikin Money Flow (CMF) functions in the crypto market

TL;DR
- The Chaikin Money Flow indicator measures the flow of money in the market within a period.
- It indicates trends, price reversals and breakouts of an asset.
- The activities of whales and institutional investors influence the prices of cryptocurrencies.
- The Chaikin Money Flow indicator is a single line that exists at the bottom of trading charts.




Introduction
The crypto market comprises two key players, large whales and retail investors. Whales and large institutional investors are responsible for moving large sums of funds in and out of the market. As a result, their activities have a greater effect on price movements than that of small retail traders.

Traders should observe the money flow that occurs in the market as it influences the price of specific cryptocurrencies. Several technical analysis indicators including the Chaikin Money Flow (CMF) indicate the flow of money in the crypto market. For instance, if investors buy large quantities of a cryptocurrency there is a large inflow of money in the market. However, if they sell them, money flows out of the market.
In this article we discuss how traders can use the Chaikin Money Flow indicator to tell when the market is accumulating or distributing cryptocurrencies.

What is the Chaikin Money Flow?

Developed by Marc Chaikin in the 1980s, the Chaikin Money Flow is an indicator that measures the amount of money that flows within a period. March Chaikin believed that price movements are different since some are backed by large trading volumes while others are supported by low volumes.


The price movements that are supported by large trading volumes are stronger than those accompanied by low volumes. In simple terms, you can tell a strong uptrend by a large trading volume that supports it.

Also, if the closing price during an uptrend is closer to its lows the trend is weak. However, if the price closes near the period’s highs it is a strong uptrend. Having said this, it is important to say that traders use a Chaikin Money Flow to estimate the strength of the trend, confirm trends and spot potential price reversals and breakouts.

The Chaikin money flow is an oscillator that appears as a single line at the bottom of trading charts and it fluctuates around the zero or centre line.

As you observe on the chart, the green line is the Chaikin money flow indicator which oscillates around the zero line.

How to calculate the Chaikin money flow

To calculate the Chaikin money flow we need four figures namely the close, the low, the high and the volume. Although it’s best to calculate it on a daily basis you can use any time frame such as an hour or a week. However, the default period is 21.

Once you have the figures we mentioned, you use the following formula.

Daily Money Flow = [(Close – Low) – (High – Close) / (High – Low)] * Volume.
From there, you use the daily money flow figures to calculate the Chaikin money flow. In this case, you use the next formula.
Chaikin Money Flow = 21-Day Average of Daily Money Flow / 21-Day Average of Volume
Usually, the Chaikin money flow is a figure between -1 and +1, although some platforms, sometimes, use the range -100 to 100. Thus, in general terms, the Chaikin Oscillator fluctuates between -1 and + 1.

How to use the Chaikin Money Flow Indicator

The centre line is very significant when interpreting the Chaikin money flow indicator. For example, if the Chaikin Money flow indicator is above the centre line there is buying pressure in the market. Conversely, if the indicator is below the zero line there is much selling pressure.
This indicator works well when the market is trending. Therefore, it gives false signals if the market is ranging. Basically, when the indicator is above the centre line and is moving up, you buy the asset.

Nevertheless, there are situations when the price is rising yet the volume is low, this indicates a weakening momentum. In this case, its readings are very low. If the indicator is below the centre line and it is falling you sell the asset.

How to determine the market trend

It is very easy to determine the market trend using the Chaikin Money Flow indicator. This is because the zero line is the dividing line between an upward trend and a downward trend.

If the indicator is above the zero line and the price as well as the volume are rising there is a strong uptrend. When the indicator is below the zero line and the price as well as the volume are falling it's a strong downtrend.

As observed, at point A, the price is rising while the indicator is above the zero line and is also rising. This is a clear indication of a strong upward trend.

Divergence
Traders can also use Chaikin Money Flow divergences to make trading decisions. There is a divergence if the price and the indicator move in opposite directions. Like most oscillators, there is a bullish divergence and a bearish one.

Bullish divergence
A bullish divergence occurs when the price of the asset falls while the indicator maintains its current position or rises.

As you note on the chart, the price is falling while the indicator is rising. Although this is a buy signal, the trader should wait for confirmation from price action or other indicators.

Bearish divergence
This occurs when the price increases while the indicator maintains the current position or falls.

In this case, the price is rising while the indicator is falling. As such, this is a sell signal. Therefore, the trader should look out for the best trade exit point.

Conclusion

In short, the Chaikin Money Flow helps traders to identify market trends as well as spotting potential price reversals. However, it is best to use this indicator alongside others such as the moving average and the relative strength index (RSI).



Author: Mashell C., Gate.io Researcher
This article represents only the views of the researcher and does not constitute any investment suggestions.
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