how the MFI works

Tasuki

Hi, I've got a question about how the MFI indicator works:
Let's say that a stock is going down and the smart money is shorting it. After a sizeable decline, there's often what's called a "dead cat bounce" where price goes up for a short while and commentators (and traders) will often say that "the shorts are covering their positions".
If this is indeed the case, if shorts are covering, would you expect the MFI to go up, or go down?
I wish I understood the MFI better---it's all about "money flow" of course, but I would think that the MFI would go up, wouldn't it, because even if you're just covering a short, money is still flowing into the stock, right? Or have I got it all wrong?
I'd really appreciate someone straightening me out on this. Thanks!

Tasuki

BTW, I asked Stockcharts, and they told me to ask you folks!

markd

Do you have an example where it doesn't eventually turn up with price?

It may not turn up as soon as you would expect because, first there is a built in lag to the ratio, and second, it is volume weighted. If there is considerably heavier volume on bars where the "typical" price ( (h+l+c)/3 ) is lower (not necessarily a bar with a down close), or considerably lighter volume on bars where the typical price is higher, then MFI will be slower to turn. It's not unusual for downside volume to be very high going into a selling climax and upside volume relatively low after a selling climax - in fact, the low volume is an indication that sellers are mostly gone - buyers have to bid up to encourage a sale. Low volume is also a pretty good indication that the buyers are covering short sellers. Value players would not normally bid prices up so high so fast because they are more patient and price sensitive. So it takes time for the heavy climax selling to leave the calculation so the ratio can turn up.

Tasuki

Thanks, mark. Actually, the question I was asking was simply whether the MFI would go up regardless of whether the buying came from new longs or shorts covering, assuming (for simplicity) similar volume in either case. The more I think about this, the stupider my question sounds. Of course the MFI would go up in either case because it's just buying, regardless of whether that buying is opening or closing a position....at least I think that's right. If not, somebody please straighten me out.

markd

I think that's right. The data stream only tells you up tick or down tick. It doesn't tell you why.