Trading Technique

Chaikin Money Flow and Other Indicators

It is best to choose indicators that complement each other. In a recent interview with Technical Analysis of Stocks and Commodities magazine, Marc Chaikin advises against using indicators that have common characteristics. It would be redundant to analyze both Momentum and MACD. These are both momentum oscillators that are based on the closing price and reflect the rate of change. Their signals will not be exactly the same, but it would be a waste of valuable time to analyze both. Chaikin singles out the Stochastic Oscillator, CCI and RSI as similar indicators. All three are banded momentum oscillators that are good for detecting overbought and oversold conditions. Buy and sell signals are also generated in much the same fashion. All three are excellent indicators, but it would be a waste of time to follow all three when one will be sufficient.

Chaikin Money Flow can be used to identify the tradable trend. If Chaikin Money Flow has been above zero for most of the past three months, then prudence would dictate that the tradable trend is up. The oscillator is indicating that buying pressure prevails. It would not be sensible to attempt a short sale if the tradable trend is up. By identifying the tradable trend, traders can ignore bearish signals and only pay attention to signals that concur. If Chaikin Money Flow indicates that buying pressure prevails, then positive divergences, bullish moving average crossovers, bullish centerline crossovers and bullish oversold crossovers would be potential buy signals. (A bullish oversold crossover occurs when an indicator advances above the oversold line. This would be a move from below 30 to above 30 for RSI). All bearish signals would be ignored, at least as long as Chaikin Money Flow indicated that buying pressure reigned.

One possible combination of indicators would be the following:

• Chaikin Money Flow - A non-trend-following volume indicator to identify buying and selling pressure.
• RSI - A momentum indicator used to identify potential overbought and oversold levels.
• Moving Averages - A trend-following indicator to identify the underlying trend in the stock.
• Price Relative - A comparative indicator to identify the strength of the stock relative to a major index.

These four indicators have little in common and complement each other very well.

Chaikin Money Flow and SharpCharts

With SharpCharts, CMF can be charted above, below, or behind the price plot window. The default value for the indicator's duration is 20-periods, but any period can be used. Simply enter the desired duration in the Parameters text box.

Conclusion

Chaikin Money Flow is an indicator that is best used in conjunction with other aspects of technical analysis. This is usually the case with indicators, but probably even more so in this case. The oscillator is unlike a momentum oscillator, and is not influenced by the price change from day to day. Instead, the indicator focuses on the location of the close relative to the range for the period (daily or weekly). This is the strength of Chaikin Money Flow, but can also be its weakness.

Because Chaikin Money Flow does not reflect the change in price from day to day or week to week, large opening gaps are sometimes not reflected in the indicator. Sometimes the indicator moves in the opposite direction of the gap, and creates a misleading picture.

Starbucks (SBUX) formed a large down gap on 1 July with extremely heavy volume. Even though the stock opened more than 10 points lower, it managed to close on the High for the day. Strong Closes indicate accumulation, and the heavy volume amplified this message to cause a large jump in the indicator. The strength was a bit misleading, and the indicator slowly declined over the next 20 days. On the 21st day, the data from 1 July was removed, and the current day's data added. This caused an immediate drop in the indicator. The Chaikin Money Flow was well below zero the next day, reflecting more accurately the selling pressure taking place in the stock.

Even though Chaikin Money Flow can be used on an intraday, daily or weekly basis, it was designed with daily data in mind. One day is an unambiguous time period with measurable volume and a specific Open, High, Low and Close. This preference may lessen in the future, with the proliferation of after-hours trading, but determining the location of the Close relative to the High and Low is still fairly straightforward. When dealing with weekly or monthly data, the beginning and end are less precise. This imprecision can affect the location of the Close relative to the High and Low for the period. Weekly is obviously more definable than monthly, but less definable than daily. This is something to consider when analyzing Chaikin Money Flow with periods other than daily.

Chaikin advocated a 21-day time frame for Chaikin Money Flow. If Chaikin Money Flow is to be used on a weekly chart, a shorter time frame will probably work better. A 21-day period represents about one month of trading, and will allow for some smoothing. A shorter time frame might prove too choppy, but a longer time frame may lag too much. Each security will have its own optimum time frame.

Keep in mind that the short-term trend is not as important as the absolute level. As long as the indicator remains above zero, it is considered bullish. It is also important to gauge the length of time that the indicator remains positive. If the indicator is positive for 7 out of 9 weeks, then buying pressure is the order of the day. The two negative weeks are a blip on the radar, and should not be taken out of context.