How to Use The Chaikin Money Flow Indicator

One of my favorite indicators tracks the volume and the market’s performance. By combining volume and price, I believe we see a qualitative view of the market. Any experienced trader recognizes that during uptrends, the volume rises on up movements, and the volume subsides during the consolidation. Likewise, if a market is in a down trend, the volume increases as prices fall, and the level of volume recedes as prices recover. My favorite indicator for measuring volume relative to the price movement is the Chaikin Money Flow (CMF) indicator.

Developed by Marc Chaikin, the Chaikin Money Flow indicator is the ratio of the summed price-weighted volume to the total volume over the lookback period. The calculation measures where the market closes within each bar relative to the bar’s range, creating a weighting factor ranging between +1 to -1, which is multiplied by the bar’s volume. This is the numerator and the denominator is the total bar’s volume.

The formula for the CMF indicator:
Each bar’s volume is weighted as below:
(((close - low) - (high - close)) / (high - low)) * volume

Then sum the above values over the lookback period. Divide this result by the sum of the volume over the lookback period.

I use the default value of 21-periods. The chart below is the Diamonds Trust (DIA), a tracking stock for the Dow Jones Industrial Average.

The CMF turned negative in late August, and again positive in early October. You may look at this and think that the CMF lags the trend, and it does. The fact is there is no Holy Grail. However, using this indicator as a basis for the long term trend of a stock is a starting point that tells you that if the CMF is running positive, then you should look to buy pull backs, and if the CMF is negative then you stay on the sidelines, look to another stock, or look for shorting opportunities.

Because the CMF is a ratio of the price-weighted volume to the total volume, it will tend to be positive during up trends, which is due to the fact that a strong market will close the majority of the time in the upper portion of the bar’s range with better than average volume. Pullbacks during an uptrend will be accompanied with less than average volume.

During a downtrend, the market will close in the lower portion of the bar’s range with expanding volume. Countertrend rallies should be accompanied with less volume than the declines. The ratio will reflect this activity with negative readings.

I also look at the CMF on a weekly basis using a lookback period of 4. This filters out the day-to-day noise of the market.