Money Flow and Market Sentiment

I have been tuning the views of my Thinkorswim charts to include both money flow and market sentiment in an attempt to better understand the underlying dynamics that may be driving specific price action up or down.  The Money Flow Index (MFI), is a momentum indicator that uses price and volume to measure buying and selling pressure in a given security. The MFI is measured in a range from zero to one hundred, signaling a potentially overbought condition when above 80 and an oversold condition when the indicator is below 20.  

Theoretically, if the asset’s MFI is over 80, then considering selling is prudent as the asset appears overbought. Conversely, we should consider buying an asset when its MFI is less 20 as this may reflect the selling may have been over done.

Moreover, as we look at the price action and the MFI, we can gain some potentially helpful insights. For example, if we find the asset closes at a higher high, but the MFI makes a lower high, then this suggests weakening buying pressure and that the asset price may fall in the near term. Conversely, if the asset price makes a lower low, but the MFI makes a higher low, then this may suggest weakening selling pressure and that the asset price may rise in the near term. 

So now that we have covered MFI reflecting the money flows into or out of an asset, what can we get from an asset specific market sentiment reading. Market sentiment is the overall attitude or feeling of investors towards a particular market, and gauges the mood as bullish or optimistic that prices will increase, or a mood that is bearish or pessimistic that prices will decline.  

Investor psychology is important as humans may have inherent biases in their decision making that lead to poor financial decisions and outcomes. Specifically, the fear of missing out or FOMO is often a psychological bias that drives investors to pile into the same investment as others. This FOMO concept, coupled with a herd behavior, where large number of investors follow the crowd and similarly pile in or bail out of a given asset. This herd mentality has been attributed as a contributing factor to both market bubbles and crashes. Investors buy the same thing at the same time, driving up the price and creating a self-fulfilling prophecy, followed by investors getting scared at the same time and selling all at once. In low volume environments, where the number of shares either bought or sold is relatively small to the overall market capitalization’s implied shares outstanding, then violent swings up and down are common.  My experience with high volume, high liquidity assets, is that the swings up and down are not as extreme either way.   

In summary, I have found the added insight of both money flow and market sentiment to be a good barometer to help inform my buy, sell or hold decisions. While imperfect, the two inputs can help improve the confidence I have in my decisions; and when coupled with portfolio sizing and positioning rules, MTM, and time and timing considerations, I can arrive at a buy, sell, hold decision more quickly.