Technical indicators can be a great guide for finding an opportune time to get in and out of the markets. They’re essentially based on changes in price and volume of a stock or exchange-traded fund.
The problem is there are so many out there that it’s hard to keep track. And it’s also tough to know how to use them.
One way to use them is to buy in when they signal that the stock price is unusually low or weak.
The opposite is also true: Some people use technical indicators to buy into big rallies when everyone else is buying that same thing, pushing the price up.
I believe that there are certain benefits to taking either approach, and one of my favorite technical indicators can be used in a way that takes advantage of the best qualities of each one.
This indicator has the potential to almost triple your gains compared to the market if you use it the way I’m about to show you.
Chaikin Money Flow
The name of the indicator is the Chaikin Money Flow (CMF). The basic idea behind it is measuring how much money has been going into or out of a stock over a specified period of time. (You can find more information on it here.)
The Chaikin Money Flow or CMF is available to use on a wide variety of websites and brokerage accounts, and it’s easy to use in spotting trends in the market.
In fact, since 2010, there have been 129 buy signals based on this indicator, and the six-week average return on investment is 7.9%. If you had bought the S&P 500 Index during these trades, your average return would be only 3.5%.
If you project those returns out over a whole year, it’s 89.4% for the CMF trades, compared to just 33.5% for the market.
Timing these trades on the overall market isn’t bad at 33.5% per year, but that doesn’t come anywhere close to the 89.4% you would have made on the individual stocks. The strategy is also profitable on 70% of its trades.
The Flow of Money
You would think that you’d be able to tell where money is flowing just by looking at prices, but the indicator is a lot more complicated. It compiles data from every day to give you the real trend.
The default way to use the Chaikin Money Flow indicator is by looking at the flow of money in and out of the stock for the past 21 trading days. But I believe you have to go farther back than that to get good results.
The way that I use it is by looking at the past 50 days in addition to the normal 21 days. Below is an example of how the indicator looks.
The top graph is the price of Seagate Technologies (Nasdaq: STX). Below that, in order, are the 50-day CMF and the 21-day CMF.
So, the top of the two red/green sections is looking at the trend of the money going in and out of the stock for more days, which means it has more of a lag and typically moves somewhat slower.
When the flow is net negative, which means there is more money coming out of the stock than going into it, the value of the money flow is below 0, and the chart shows it as red. And when there is more money going into the stock, it crosses above 0 and turns green.
The way that I used this indicator to almost triple the market’s return was by timing the trade to buy when the 21-day CMF was above 0, and the 50-day CMF was about to cross 0 also.
That means there was recent momentum, and long-term momentum was about to turn positive too.
The example above with Seagate resulted in a 56% gain in the stock in just six weeks. But if you had held onto it until now, you’d have a huge 152% gain instead.
Another key element to this strategy is that I only use it on stocks that have gone down by 30% or more in the past year.
This helps me time the trade when a lot of buying momentum is coming into the stock, and it focuses on stocks that have underperformed over the past year and may now be facing a turning point with this momentum shift.
One example is Advanced Micro Devices Inc. (Nasdaq: AMD), which the CMF signaled to buy on April 9, 2013, at $2.63.
By May 15, it was $4.38, up 67% in just five weeks.
Another is Newfield Exploration Co. (NYSE: NFX), which had a buy signal on February 19, 2016, at $22.31.
It shot up by 50% in less than a month, and hit 100% after about four and a half months.
These are just a few examples of a bunch of trades that have made big returns in a short amount of time based on one simple indicator, the Chaikin Money Flow.
Internal Analyst, Banyan Hill Publishing
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