Neil GladwinIn last week's Trading Tutors Newsletter, we discussed the Accumulation/Distribution Line developed by Marc Chaikin. I thought it would be fitting this week to look at the Chaikin Money Flow (CMF) indicator which uses the Accumulation/Distribution Line in its calculation. We will start by taking a quick look at how the CMF is put together and then go into some examples of how we can use this in our technical analysis of a chart.
When we talk about bullish or bearish moves in the market, one of the most important things to take into account is whether or not the moves are supported in volume. What the CMF indicator does is measure the market strength by looking for increased volume and prices closing in the upper half of the trading period’s range. Similarly, market weakness is usually shown with prices in the lower range with an increase in volume also.
CMF works by taking the values of the Accumulation/Distribution Line for a number of periods and dividing each value by the sum of the volume for the same time-period. Normally 21 days is used as a default as it is considered to give a good illustration of the buying and selling over the last month.
Let’s now take a look at how you can use an indicator like the CMF in your charting. What we are primarily looking for is divergence between the price movements and the CMF indicator.
Looking back at 2005 on the BHP chart below you can see that whilst the price was headed in a fairly strong upward direction during February and into March, the CMF was heading downward. Eventually something had to give and it was the price of BHP that had a significant pullback and not to my surprise found some strong support on the 200 Day Moving Average. Take a look then at what happened from the middle of April into mid-May. Again we started to see some divergence between the price as it headed down and the CMF proceeded to march strongly upward shortly followed by a rebound in the share price of BHP.
Chart 1 – BHP Daily Bar Chart
click chart for more detailSo what is BHP doing at the moment? Look at the chart below and see what BHP is doing right now. Notice any similarities yet?
From February through to April we saw BHP gain in price very strongly. However, taking a look at the CMF indicator tells a different story with some pretty strong divergence taking place. We did see the pull-back in price and wouldn’t you know it, BHP pulled up right on the 200 Day Moving Average, once again proving this to be a strong support area whilst setting up some strong divergence between the share price and the CMF from May to now.
Chart 2 – BHP Daily Bar Chart
click chart for more detailIndicators such as the Chaikin Money Flow are best used to give extra confirmation before taking your position in a trade. Again I would suggest that you choose some stocks and back test some of your favourites to get a good feel for how this one works.
Good luck with your trading!
Neil Gladwin