- The Chaikin oscillator measures the Accumulation/Distribution Line of MACD.
- A cross above the ADL indicates that investors are accumulating (buying).
Price follows volume, based on an old investing axiom. When traders buy a large number of shares of a stock that appear unusual, sellers don’t trade at that price. The theory is, when investors are aggressively buying, the desirability and scarcity of the stock yield greater prices. Let’s go into details about the Chaikin Oscillator.
Just as it is with other technical analysis tools, the Chaikin Oscillator helps predict the price movements of future assets – especially detecting turning points in the price of an asset. It is sometimes mistakenly referred to as the Chaikin volatility indicator.
The Chaikin Oscillator (CHO) tries to achieve this by observing momentum the volume flow of an asset by measuring the accumulation/distribution line of the Moving Average Convergence Divergence (MACD). This makes it an indicator of an indicator – giving traders the luxury of two technical analysis tools.
Marc Chaikin is the creator of the CHO indicator. It is the difference between the 3-day and 10-day EMAs of the accumulation/distribution line. It creates signals that cross above/below the zero lines or with bullish/bearish divergences.
What is the Chaikin Indicator?
The Chaikin oscillator measures the accumulation/distribution line of moving average convergence/divergence (MACD). For traders to calculate the Chaikin indicator, they need to subtract a 10-day exponential moving average (EMA) of the accumulation/distribution line from a 3-day EMA of the accumulation/distribution line. This measures momentum determined by oscillations around the accumulation/distribution line.
The CHO indicator takes accumulation/distribution (ADL) and applies two Exponential Moving Averages of different length to the line. The value of the indicator is then gotten by subtracting the longer-term EMA of the ADL from the shorter-term EMA of the ADL. This serves as a way to measure the momentum of the ADL by plotting a line that fluctuates between positive and negative values.
Being aware of changes in momentum can help an investor or technical analyst to anticipate trend changes. It helps them because changes in momentum often precede changes in trend.
The Chaikin indicator is more accurate than the On Balance Volume indicator.
On Balance Volume
This adds all volume for the day if the close is positive, even if the stock closed only a penny higher. Or it subtracts all volume for the day if the stock closes at a lower range.
It factors in the closing price relating to the lows, highs, and average price. It also determines the appropriate ratio of volume for the day.
The main aim of the Chaikin indicator is to try to confirm price trends and try to warn of impending price reversals.
What does the Chaikin Indicator tell traders?
The CHO indicator is a tool used by technical analysts more than it is for fundamental analysts. These analysts study the business performance of a company to gather data about the future direction of its stock price. Fundamental analysts believe that the skill required in predicting the market is about being the most informed.
Technical analysts, on the other hand, believe that all known data is already priced into stocks. Also, patterns in the ups and downs of equity prices can better predict the movements of the market. Technical analysts make use of the Chaikin oscillator to locate directional trends in momentum.
To appreciate how traders use an indicator, imagine that you are at an auction. On one side of the room are buyers or accumulators. On the other side are the sellers or distributors. When there are more sellers than buyers, the price of an item reduces. In the same way, when buyers are the majority, the price of the item increases.
Traders believe that the balance of this relationship is what powers financial markets. They measure this balance between sellers and buyers with various indicators, including accumulation/distribution indicators such as the Chaikin oscillator.
Chaikin’s three premises
Chaikin says that the premise behind my oscillator is threefold. The premises are:
- If the price of an asset ends higher than its midpoint for the day, then there was accumulation that day. The closer an asset closes to its high, the more accumulation there was. On the other hand, if an asset closes lower than its midpoint for the day, there was distribution on that day. The closer an asset closes to its low, the more distribution there was.
- A healthy advance follows a rising volume and a strong volume accumulation. Because volume is the fuel driving rallies, it follows that lagging volume on rallies is an indication of less fuel available to drive stocks higher.
- By using the Chaikin indicator, you can monitor the flow of volume in and out of the market. Comparing this flow to price action helps in identifying bottoms and tops, both short-term and intermediate-term.
How to use the Chaikin Indicator?
An investment technique based on indications that the Chaikin indicator provides can work well. But it has its limitations and can occasionally generate misleading signals.
This is why professionals advise traders to trade the different indicators in conjunction with other tools. A pairing of the Chaikin and Stochastic oscillators, for instance, will perhaps work well. It is up to the individual investor to discover what works well for them.
Chaikin himself said that “since no technical approach works all the time, traders should use the oscillator together with other technical indicators to avoid issues. Use a price envelope around a 21-day moving average and an overbought/oversold oscillator with the Chaikin indicator to get the best short-term and intermediate-term technical signals.”
Chaikin Oscillator and RSI Strategy
Since Chaikin is an indicator of an indicator, don’t use this indicator standalone. It regularly lags, and if you use the lower period settings, it provides many false signals. You can pair the Chaikin Oscillator with the Relative Strength Index (RSI) indicator.
RSI is a popular indicator in the trading community. It is also an oscillator, and it oscillates between 0-100 levels. RSI reading higher than 70 signals overbought conditions. While the reading lower than 30 signals oversold conditions.
So the strategy is to see if the RSI is either at the overbought or oversold places. In the same way, the Chaikin Oscillator needs to be above or below the zero-line to show a potential buy or sell signal.
Chaikin Oscillator and Divergence
Divergence happens when the price of the currency is going in one direction, but the indicator is moving in another direction. Divergence tells traders that the recent price of the currency is weakening, and they should expect a trend reversal. The divergence can either be bearish or bullish.
When the prices hit higher highs, but the oscillator doesn’t follow the price, it means that the uptrend is weakening. Also, price reversal may soon happen. Traders call this the bearish divergence.
When the price is hitting a lower low, but the indicator is moving sideways or not making a lower low, it means that the downtrend is losing its momentum and a price reversal will occur. Traders refer to this as a bullish divergence.
The indicator should anticipate the trend changes in the accumulation/distribution line by measuring the momentum behind the movements. This indicator gives traders signals in two ways.
- When it crosses the zero line from above, it is a sell signal. When it crosses the zero line from below, it is an indication to buy.
- This indicator also generates signals of both bearish and bullish divergences in the market.
The Chaikin indicator makes technical output that supports good sell or buy decisions. But it is best used together with other technical indicators.