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Tracking Money Flow To Spot Reversals

Among dozens of valuable technical indicators, one in particular - the Chaikin Money Flow (NYSEARCA:CMF) - may provide an early signal of coming trend reversal. While CMF also may act as a lagging indicator, when you see it turn before price turns, it makes sense to pay attention.

Most indicators are based on momentum shifts in price only. Technical pattern analysis is structured within the trading range and chartists look for resistance and support tests in many forms. CMF is different. It is based on a study of volume trends, and who is in charge (buyers or sellers) of trading activity. The indicator was developed by Marc Chaikin, an experienced trader who recognized that stock trends were usually in either an accumulation (buying) or distribution (selling) phase; but that these phases were not visible on a price-based chart. Chaikin's first formula is the well-known accumulation/distribution (A/D) line, which summarizes daily results based on buying and selling action. Each session is controlled by buyers or by sellers, and A/D summarizes that control. As a momentum oscillator, A/D identifies which side has greater strength each day using volume flow. The formula for A/D each day is:

( close - low ) - ( high - close )

= A/D

( high - low )

The outcome ends up somewhere between +1 (buyer control) and -1 (seller control). This idea is expanded over seve4ral days to find the longer-term trend, and that is where CMF comes in. CMF is the sum of many sessions (21 days are usually used to calculate the moving average), divided by total volume for the same period. This is a more complex calculation, but in today's online world of free charting, CMF and other complex calculations are performed automatically and can be overlaid on price charts.

The ultimate value to CMF is that is often acts as an early indicator of coming price reversal. This should be confirmed by other technical signs; but when you are working with an advance indicator like CMF, you can beat the crown by confirming the apparent shift in control, and make your entry or exit before everyone else.

CMF, like all indicators, can give off a false signal, further emphasizing the importance of independent confirmation; and because it consists of a moving average, it is often a lagging indicator, meaning it can be used to confirm other signals. It is, however, one of the best technical signals of early reversal in short-term trends.

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