Twiggs Money Flow vs. Chaikin Money Flow: A Quantitative Comparison

Introduction

For decades, traders have relied on volume-weighted indicators to gauge the strength of a trend and anticipate reversals. The Chaikin Money Flow (CMF), developed by Marc Chaikin, has long been a staple in this category. However, the Twiggs Money Flow (TMF), developed by Colin Twiggs, offers several key enhancements that address some of the CMF's inherent limitations. This article provides a rigorous quantitative comparison of these two indicators, designed to equip institutional traders with a deeper understanding of their respective strengths and weaknesses.

The Chaikin Money Flow (CMF): A Brief Review

The Chaikin Money Flow is calculated using the following formula:

$CMF = \frac{\sum_{i=1}^{n} (\frac{(Close_i - Low_i) - (High_i - Close_i)}{High_i - Low_i} \times Volume_i)}{\sum_{i=1}^{n} Volume_i}$

Where:

• n is the lookback period, typically 20 or 21 days.

The numerator of the CMF formula is the Money Flow Multiplier, also known as the Close Location Value (CLV), multiplied by volume. The CMF then sums the Money Flow Volume for the lookback period and divides by the total volume for the same period.

The Twiggs Money Flow (TMF): Key Innovations

The Twiggs Money Flow builds upon the CMF's foundation with two significant improvements:

1. Use of True Range: The TMF replaces the standard high-low range with the True Range, which accounts for price gaps. This provides a more accurate measure of volatility and, consequently, a more reliable calculation of money flow.
2. Exponential Smoothing: The TMF uses an exponential moving average (EMA) to smooth the indicator, rather than the simple summation used by the CMF. This gives more weight to recent data and reduces the impact of old data points dropping off the back of the lookback period, resulting in a smoother and more responsive indicator.

Quantitative Comparison: The Impact of Price Gaps

To illustrate the difference in how these two indicators handle price gaps, let's consider the following scenario:

In this example, the stock gapped up significantly on Day 21. The CMF, which does not account for this gap, would show a smaller increase in money flow than the TMF. The TMF, by incorporating the True Range, captures the full extent of the buying pressure that caused the gap, resulting in a higher and more accurate reading.

Quantitative Comparison: The

Impact of Exponential Smoothing

The CMF's reliance on a simple summation makes it susceptible to sharp movements when a large data point enters or leaves the lookback period. The TMF's use of exponential smoothing mitigates this issue, creating a smoother and more reliable indicator.

Let's consider a 21-day lookback period. On day 22, the CMF calculation drops the data from day 1. If day 1 had an unusually high or low Money Flow Volume, the CMF will experience a significant jump or drop, even if the current day's price and volume action is unremarkable. The TMF, in contrast, will only be marginally affected, as the EMA gives less weight to older data.

Trade Example: False Signal from CMF

Imagine a stock in a sideways consolidation. The CMF is hovering around the zero line. Suddenly, a large positive Money Flow Volume from 21 days ago drops out of the calculation. This causes the CMF to plummet below zero, generating a false sell signal. A trader acting on this signal would be whipsawed when the price continues to trade sideways.

• CMF Signal: Sell signal due to the indicator dropping below zero.
• TMF Signal: The TMF would likely remain relatively flat, as the EMA would have already diminished the impact of the old data point. No signal would be generated.

Conclusion

While both the Chaikin Money Flow and the Twiggs Money Flow are valuable tools for assessing money flow, the TMF's enhancements make it a superior indicator for most applications. Its use of True Range provides a more accurate picture of buying and selling pressure, especially in the presence of price gaps. Furthermore, its reliance on exponential smoothing results in a smoother, more responsive, and less error-prone indicator. For institutional traders seeking a robust and reliable measure of money flow, the Twiggs Money Flow is the clear choice.