Chaikin Money Flow (CMF): Understanding When Whales Are Buying

Two main players in the financial markets are the large whales and the small retail traders. The large institutions and whales are the ones who typically move the market’s pricing, whereas the small retail trader typically doesn’t. Therefore, the small retail trader can gain an edge if they can spot where the big money is flowing.

Technical indicators like the Chaikin Money Flow are designed to alert traders when the market is accumulating and set to rally higher. In this article we’ll review what the CMF is, and how to read it so you can spot where the big money is flowing. 

What Does Chaikin Money Flow Tell You? 

The Chaikin Money Flow indicator tells traders if institutions, whales and investors are accumulating and buying crypto, or distributing and selling the market. Essentially, CMF indicates the money flow behind crypto.

The Chaikin Money Flow indicator (CMF) was created by stock analyst Marc Chaikin in the early 1980s as a way to measure the strength of a trend combined with the volume behind it. The CMF assumes that not all price trends are created equal. A price trend that’s moving higher, but closing each day near its low, is a weak uptrend compared to one with daily closes near the highs.

Trading volume also factors into a trend’s strength. An uptrend on weak or slowing volume is a sign of a weakening uptrend. On the other hand, strong and growing volume is a healthy sign of a strong uptrend.

The CMF was designed to mix these variables into one easy-to-read indicator that prints below the price chart and helps traders identify buying and selling pressure within the market.

What the Chaikin Money Flow Indicator Looks Like

The CMF appears as a line or area graph in a window, separate from the crypto’s price chart, oscillating between −100 and +100. This range makes it a bounded oscillator.

Many charting packages offer the CMF with the default setting of 20. However, a better default setting when using the CMF for crypto is 21 or 28, since many of the other markets only trade five days per week — and those markets contain about a four-week cycle of 20 trading days. This allows the indicator to capture a full cycle.

Crypto trades 24 hours a day, seven days a week. Therefore, 20 trading days is less than three full weeks. A 21 input setting allows for three full weeks, and a 28 input setting allows for a full four-week cycle.

The most important point within the CMF indicator is the zero line. When the CMF is above zero, the crypto trend is said to be higher. When the CMF is below zero, then the trend is considered to be lower. There may be instances where the price is moving higher, but on weakening volume. In those situations, the CMF prints lower readings, alerting the trader to slowing momentum to the upside.

How the CMF is Calculated

There are three parts to the calculation of the Chaikin Money Flow.

The first part includes figuring the money flow multiplier.

Then, find the product of the money flow multiplier above and the total volume for that period.

Lastly, add up the products above for the number of periods set within the indicator (recommended 28 periods) and divide the result by the 28-period sum of the total volume.

As a result, the CMF depends on the value of the money flow multiplier. This value is positive when the closing price is above the midpoint of the range, and negative when the closing price is below the midpoint of the range.

If the volume is heavy, then that multiplier swings even further away from the zero line. If the volume is light, then the effect of the multiplier is muted.

Pros and Cons of Using the CMF

Like any indicator you apply to the charts, the Chaikin Money Flow indicator has its strengths and weaknesses. Once you’re familiar with its pros and cons, you can carefully apply the indicator to help maximize results.

Strengths:

• CMF helps traders confirm the strength and direction of a trend

• Easy visibility of divergence between price and CMF — so traders can time entries and exits better

The CMF is a momentum indicator. Therefore, it’s most useful when applied to trending markets, where it helps crypto traders determine the strength and direction of a trend.

Once a trend loses strength, that loss of momentum appears in the indicator as divergence, alerting crypto traders to a potential trend change.

Weaknesses:

• Plenty of false signals during a volatile market, when trends aren’t certain

• CMF is a lagging indicator that trails the price

• Possibility of whipsaws, causing poor entries and exits

Like all indicators, the CMF isn’t always 100% accurate, and. a trader needs to keep the CMF’s limitations in mind. For example, when the market isn’t trending, the propensity for false signals increases dramatically  — especially when there’s volatility of price. 

This is because the CMF indicator utilizes a moving average of the price and volume. The moving average of these variables tends to lag, and won’t react as quickly to abrupt changes in market conditions.

How to Use the CMF Indicator

The CMF indicator has two primary uses: to determine trend direction, and trend strength.

Determining trend direction is fairly easy. First, the zero line is the barrier dividing an uptrend from a downtrend. When the CMF indicator is above zero, price and volume trends are present, suggesting that the trend is strong or growing.

When the CMF indicator is below zero, the price and volume trends are implying a downtrending market.

In many instances, the CMF indicator will hover right around zero. This generally happens during a pullback within an uptrend or a rally within a downtrend. A pullback to the zero line offers crypto traders an opportunity to enter new positions in the direction of the trend.

The CMF Indicator and Divergence

At important pivot points within the larger trends, divergence will appear using the CMF. Divergence is when the price is moving in one direction, but the CMF indicator is moving in the opposite one.

For example, in the daily Bitcoin chart above, notice how during March and April 2021 Bitcoin’s price continues to move higher while the CMF creates a series of lower highs. These lower highs on the CMF occur because the closing price of the daily candles isn’t in the upper portion of the day’s range. 

Additionally, if the volume of trades on the up days is relatively muted — or the volume of trades on the down days is heavy — then the volume portion of the CMF will weigh heavily on its output.

The opposite is true when the market is correcting lower. When the price continues to dip and reach lower lows, look for the CMF to form higher lows as a sign of bullish support.

During the summer of 2021, Bitcoin corrected quickly, reaching its lowest closing price since January 1. Though the correction was aggressive, the inability of the CMF indicator to follow price lower was a clue that buying interest was developing for Bitcoin.

After the bullish divergence appeared, Bitcoin went on to double its price over the next several months.

Chaikin Money Flow vs. Chaikin Oscillator

Though similarities exist between the Chaikin Money Flow and the Chaikin Oscillator, the math behind each of the indicators and how to interpret their signals is quite different.

Both indicators were created by Marc Chaikin. However, the oscillator operates similar to the moving average convergence divergence (MACD) indicator, due to its use of two exponential moving averages. The MACD indicator calculates momentum by comparing the 12-period and 26-period exponential moving averages.

The Chaikin Oscillator (CO) uses the 3-period and 10-period exponential moving averages of the CMF, and is said to be in an uptrend when the indicator is above zero. When the CO indicator is below zero, then a downtrend is in force.

Some traders prefer using the Chaikin Oscillator, as it tends to react more quickly to reversals in the market.

For example, on the Ethereum price chart above, notice how the Chaikin Oscillator crosses the zero line before the Chaikin Money Flow indicator. This is because the CO is using exponential moving averages to capture the momentum of the market.

CMF Trading Strategies

The CMF is useful in determining trends and divergences. However, making it a core part of a trading strategy leaves the strategy flawed and susceptible to whipsaws. 

Therefore, here are three suggestions for additional tools to use with the CMF to strengthen its signals.

CMF With a Zero Line Buffer

Buying the market when the CMF falls to zero is a good way to buy the dip. But how can you tell if this is just a dip, or a larger correction that may carry the CMF significantly below zero and into a new downtrend?

One way around this is to add buffers to both sides of the zero line. A common buffer used by crypto traders is +0.05 and −0.05.

Therefore, when the CMF is dipping back to zero, the crypto trader won’t sell until −0.05 is broken to the downside. Once −0.05 is broken to the downside, then the probability of a larger correction increases.

Similarly, a trader won’t buy until the CMF crosses back above the +0.05 mark. That way, even if the CMF dips briefly below zero, we have confirmation that the crypto market may continue to accelerate higher.

CMF and EMA

One drawback to using the CMF as a stand-alone indicator is that identifying risk and take-profit levels can be elusive and inconsistent. Therefore, incorporating another indicator to confirm the trend will help traders identify risk and take-profit levels, complementing the CMF nicely.

For example, applying a 9-period and 34-period exponential moving average (EMA) to the chart can act as a timing tool for entering and exiting a position. The trader would first look for the CMF to be above zero, then take only long positions when the 9 EMA crosses above the 34 EMA. A moving average crossover strategy is a common way to enter into positions.

Similarly, a sell signal is indicated if CMF divergence appears, or if the CMF drops below zero. 

CMF and Trend Lines

Rather than using trend lines as support and resistance levels, we can use trend lines to help indicate potential pivot zones.

On the daily price chart for Ethereum, above, we can see a long-term support trend line is in place from March 2020. This trend line has supported the Ethereum price through the entire uptrend of 2020 and the correction of 2021.

A trader may notice that when the price corrects lower in the summer of 2021, Ethereum merely revisits the trend line support.

At that point, the CMF indicator is hovering near the zero line, indicating that the longer-term trend is still pointed higher. In this instance, the CMF confirms the longer-term trend, and the trend line would be the timing indicator to enter.

An Ethereum trader could buy on the touch of the trend line and place a stop-loss just below the trend line. If the trend line breaks, then the mood of the market is changing, and the trader will want to exit the trade.

After bouncing higher in July 2021, Ethereum comes back to retest this trend line in September 2021, then bounds higher.

The Bottom Line

The Chaikin Money Flow indicator can be useful for spotting momentum-related trends like when big whales are moving in the crypto market. It’s a simple indicator that’s easy to read. However, the CMF is not a perfect indicator by itself, which is why many traders combine it with other tools, such as moving averages and trend lines.