Prices
always follow the Flow of fund.
To illustrate, even with major negative fundamental events, share prices can still go up where buying is continuous and dominant.
On the opposite side, price will go down whenever
the flow of fund is going out of the market despite any good news.
This article is written to prove above statement and is not covering any other technical analysis than
Flow of fund.
To facilitate a more intuitive description of the relationship between price and money
flow, I created the flow of fund indicator.
Divergences are added to the new edition as they play key roles in this analysis.
The charts blow are screen shots from NinjaTrader platform. With the old edition that does come with divergences,
users can still deduct when price and money flow have decoupled with their own eyes, you just have to look more closely.
To briefly introduce how to use flow of fund indicator ( “FOF”)
·Fast length: to calculate flow of fund within given bars, shown as light blue line in the chart. Suggest to set a relative smaller number.
·Slow length: to calculate flow of funds within given bars, shown as orange line in the chart. Suggest to set a relative larger number.
·Percent: Percentage change from previous peak/trough to recent peak/trough.
·Previous range: to define previous peak/trough within given bars.
·Recent range: to define recent peak/trough within given bars.
The red arrow that’s pointing down on a specific candle stick ( as shown in the picture blow) is automatically derived from the divergence feature within FOF indicator.
With predefined parameters, the indicator will calculate divergence automatically and if it exists, it will present it with an red arrow pointing down.
The white arrowed line is added afterwards to demonstrate price and money have moved into different directions
Next, we will see if we can correctly detect US market trend with only FOF indicator.
I will use E-Mini Nasdaq 100 (NQ) futures price as first example. If similar results can be achieved, I will update charts with future prices from SPY, QQQ, DIA and other US markets.
As shown below, the chart is E-Mini Nasdaq 100 (NQ daily, the top white arrowed line marks price trend from the end of January to beginning of February
and the bottom white arrowed line indicates the trend on flow of funds within the short period of time (light blue line).
It’s quite obvious, when the indicator is making lower highs while prices are reaching higher highs.
Why the price starts to fall when divergence occurs?
This is a straightforward question every investor should pay attention to, but it is amazing how many ignore it.
The simple relationship between supply and demand is sufficient to solve this question.
When supply can’t meet demand, money will continue flow into the market results accumulation and an increase in prices.
When there is not enough demand in the market, money will stop to flow in or even start to exit. This distribution process results the prices to go down.
Let’s look at weekly chart now, from November 2014 to March 2015, within two peaks, divergence occurred again between prices and flow of funds (light blue line), only it took longer time in weekly chart that than in the daily chart above.
With the help of flow of funds indicator, we could easily detect the plunge right before it happened in August 2015.
Of course, you will find it even more useful if you are already very familiar with chart patterns.
In the chart below, FOF indicator provided two signals, we shall focus our discussion on the latter.
From June to July in 2015, there has been great volatility in share prices, new high has been established, but there is no peak emerged for short term flow of funds indicator (light blue line). Furthermore, mid-long term flow of funds indicator (orange line) has been below zero, indicating money has been continuously flow out of market.
Now, let’s look at weekly chart. From September 2014 to July 2015, red line marked price trend and flow of funds.
Within this period of time, these two have gone to completely different directions, mid-long term flow of funds indicator (orange line) has been trending low, and it broke through zero line after July. Look at near term,
although price has been climbed onto new highs, the short term flow of funds indicator (light blue line) started to diverge from the end of April. The FOF indicator gives divergence signal as shown by the red arrow,
the week prior to it is classical example of sell off when price peaks. Using these obvious signals, we can easily detect a possible large scale of price adjustment in August.
Other than divergence, the FOF indicator can also be employed to determine price trend based on differences in flow of funds in various time period.
Let’s use iShares China large-Cap ETF as an example, see how FOF indicator gives clues before HK market dives.
The chart below is daily chart on FXI, price has made new highs so does short term flow of funds (light blue line). During the same period, mid-long term flow of funds (orange line) continued to climb and maintained upward trend. Pay attention, the parameter of the orange line is set as 50, meaning flow of funds within 50 days period of time.
In May, as shown in the white square, shot-term flow of funds (light blue line) started to descent dramatically and started to deviate in great extent from the orange line.
Let’s look at two
lines of the FOF indicator within the white square below, there is a huge gap between short/long flow of funds.
Other than divergence, the gap yields another effective analysis with flow of fund indicator. If price reaches new high,
long term flow of funds (orange line) trending the same direction as the price, but short term flow of funds (light blue line) started to move towards to an opposite direction, and the disparity between the two is getting wider,
it proves the main force begins to withdraw from the market. After the main force has left,
price can not maintain at peak without fund support, simple demand and supply relationship determines a rapid decline in the price.
Let’s look at the weekly chart with FXI, it exhibits two significant divergences between mid and long term.
The red arrow generated by Flow of funds indicator automatically points out the bar when price and flow of funds diverges.
The red line marks the divergence between two peak points within longer period of time.
The white line marks the divergence between two peak points within shorter period of time.
Divergence can also be found on the monthly chart of FXI.
In the chart below, the divergence only existed between price and short term flow of funds, but long term flow of funds (orange line) synchronizes the price.
Why can we determine the price will fall only based on short term flow of funds (light blue line)?
Because long term flow of funds (orange line) can be looked at as inertial accumulation,
or simply think of it as direct relationship between 10 days moving average and 50 days moving average.
FOF indicator just like any other technical indicator, can not be used as a sole measurement, but it can indicate changes in price with great possibility.
In fact, there are a lot similarities
on the application between FOF indicator and other
popular indicators,
especially with determination in divergence, however, the distinctive comes from interpretation of the market.
The above examples demonstrated the basic uses of FOF indicator, it’s an indicator to detect price trend not to calculate price fluctuation.
The calculation on the movement is achieved through other means, not to explained in details here.
If encountered above situation in real life practice with long positions, it’s suggested to maintain or reduce position until it’s more clear with future market trend.
Without enough experience and expertise, it’s not suggested to short the market at the same position.
