The Volume Flow Indicator (VFI) is used in technical analysis in Forex Trading and it helps to understand the strength of a price trend by using both price movement and trading volume. 

The formula is based on the idea that price changes accompanied by high trading volume are more likely to be sustained.

You will not only learn the concept and importance of the VFI, but detailed calculations, along with examples, to make it easy for you to apply in your trading strategies.

What is the Volume Flow Indicator (VFI)?

The Volume Flow Indicator (VFI) aims to analyze the relationship between price and volume over some time. 

It helps confirm the strength of a trend by determining if the price movement is supported by enough market participation (volume). 

The VFI helps to measure if a price movement is likely to continue or reverse based on volume data.

The VFI formula is based on Typical Price (TP) and Volume data, smoothed by an Exponential Moving Average (EMA). 

It can give traders more confidence in their trade decisions, especially when combined with other indicators like the Relative Strength Index (RSI) or Moving Average Convergence Divergence (MACD).

How is the Volume Flow Indicator Calculated?

The formula for Volume Flow Indicator (VFI) involves a series of calculations to put both price and volume data into a single value.

Step 1: Calculate the Typical Price (TP)

The Typical Price (TP) is the average of the high, low, and close prices for a specific period. This is the formula:

Typical Price (TP) = High + Low + Close / 3

Calculation

Take for an example that the data for a candlestick is as follows

• High = 1.3050
• Low = 1.3000
• Close = 1.3020

Using the formula

TP = 1.3050 + 1.3000 + 1.3020​ / 3 = 1.3023

So, the Typical Price (TP) for this period is 1.3023.

Step 2: Calculate the Raw Money Flow (RMF)

The Raw Money Flow (RMF) is calculated by multiplying the Typical Price (TP) by the Volume for that period:

Raw Money Flow (RMF) = Typical Price (TP) x Volume

Calculation

Assuming that the Volume for the period is 200,000 units. Using the Typical Price (TP) calculated in the previous step (1.3023):

RMF= 1.3023 × 200,000=260,460

So, the Raw Money Flow (RMF) is 260,460.

Step 3: Calculate the Money Flow Multiplier (MFM)

The Money Flow Multiplier (MFM) compares the current Typical Price (TP) with the previous Typical Price and adjusts it by the range of the period (High – Low):

Money Flow Multiplier (MFM)= Current TP – Previous TP​​ / High – Low 

Calculation

Assume the Previous Typical Price (TP) was 1.3000, and the current TP is 1.3023. The High and Low values are 1.3050 and 1.3000, respectively.

MFM= 1.3023 – 1.3000 / 1.3050 – 1.3000​ = 0.0023​ / 0.0050 = 0.46

So, the Money Flow Multiplier (MFM) is 0.46.

Step 4: Calculate the Money Flow Volume (MFV)

The Money Flow Volume (MFV) is found by multiplying the Money Flow Multiplier (MFM) by the Volume:

Money Flow Volume (MFV) = MFM x Volume

Calculation

We already know that the MFM is 0.46 and the Volume is 200,000 units. Now calculate:

MFV=0.46 x 200,000 = 92,000

So, the Money Flow Volume (MFV) is 92,000.

Step 5: Smooth the Money Flow Volume (MFV)

Now that we have the MFV, the final step involves smoothing the data. This is done using an Exponential Moving Average (EMA). It smooths out short-term fluctuations to provide a clearer signal. 

The formula to calculate the VFI is:

VFI = Smoothed MFV (EMA)

Calculation

Suppose you calculate the EMA of the Money Flow Volume (MFV) over a period (e.g., 14 periods) to smooth out the data. 

After  smoothing, the final value for the VFI is 75.

Thus, the Volume Flow Indicator (VFI) for this period would be 75.

Why is the VFI Important in Forex Trading?

The VFI is important in forex trading because it combines price and volume to determine the strength of a price trend. 

When you understand the strength of a trend, it will be essential in finding out if you are to enter or exit a trade.

1. Confirm the Trend Strength

A rising VFI shows that the current price trend is supported by strong market participation (volume), which indicates a high likelihood of the trend continuing. 

On the other end, a declining VFI suggests that volume is decreasing, which may indicate a weak trend and potential reversal.

2. Spot Divergence

One of the uses of the VFI is spotting the divergence between the price and the indicator. When the price is rising but the VFI falls, it can signal that the trend is losing strength and may reverse soon. The opposite is true for a falling price with a rising VFI.

Advantages of the Volume Flow Indicator (VFI)

1. The VFI helps confirm trends by showing whether the price movement is backed by sufficient volume.

2. With its smoothed calculations, the VFI helps eliminate false signals that can occur with raw volume or price alone.

3. The VFI can spot potential reversals when the price and indicator diverge.

Disadvantages of the Volume Flow Indicator (VFI)

1. The VFI involves multiple steps and requires a good understanding of both price action and volume analysis.

2. The VFI in sideways market can produce false signals, making it less reliable in range-bound markets.

3. Due to its reliance on longer periods for smoothing, the VFI might not be suitable for very short-term trading strategies like scalping.

Frequently Asked Questions

1. What does a positive VFI mean?

Positive VFI means that the current price movement is supported by increasing volume. This normally would suggests that the trend is strong and could continue.

2. How can I use VFI in my trading strategy?

You use the VFI to confirm trends. A rising VFI with a rising price shows a strong uptrend, while a falling VFI can suggest the trend is weakening. You also use the VFI to spot divergence and that can signal potential trend reversals.

3. What timeframes are best for using VFI?

The VFI works best on medium to longer timeframes like 1-hour or 4-hour charts. On very short timeframes, it might generate too many signals, making it harder to trade.

4. Is VFI better than other indicators?

The VFI is the best because it combines price and volume, offering insights into both trend strength and market participation. However, it should be used with other indicators (e.g., RSI, MACD) for better accuracy and reliability.

Conclusion

The Volume Flow Indicator (VFI) is important for forex traders looking to assess the strength of a trend by combining price action and volume. 

When you follow the detailed steps in this guide, including the Typical Price, Raw Money Flow, Money Flow Multiplier, and Exponential Moving Average (EMA) smoothing process, you can calculate the VFI very correctly. 

As with any indicator, it’s crucial to use the VFI in conjunction with other technical tools to refine your trading strategy.