Trading using the Chaikin Oscillator
By Neil Dennis
04:00, 10 October 2018
Much like other technical analysis tools, the Chaikin Oscillator was designed to help predict future asset price movements – particularly identifying turning points in an asset price. It is sometimes mistakenly called the Chaikin volatility indicator.
The Chaikin Oscillator attempts to achieve this by observing momentum in asset volume flows by measuring the accumulation/distribution line of the moving average convergence divergence (MACD).
This makes it an indicator of an indicator – ostensibly granting investors the benefit of two technical analysis tools.
That's a lot of jargon to digest in one go, so let's break that down a little.
Moving average convergence divergence
This is a common technical analysis tool using shorter term exponential moving averages (EMA). An EMA differs from a simple moving average by giving more weight to the most recent data so that a better picture of short-term price trends can be identified.
Therefore, instead of using the longer-term 50- or 200-day moving averages, the MACD is calculated by subtracting the 26-day EMA from the 12-day EMA. A nine-day EMA of the MACD is then calculated and plotted on top of the MACD - this is called the "signal line", and is used as a buy or sell signal.
This is a tool that explores the relationship between buyers (accumulators) and sellers (distributors) of an asset by analysing divergences between price and volume flow.
First, the “money flow multiplier” is identified by calculating the difference between the closing price and the low price of the series range (a number of days for a longer-term assessment, or one- to five-minute intervals for day trading purposes).
Next, find the difference between the high price and the closing price of the range. Then, subtract the latter from the former and divide the resulting value by the difference between the high price and the low price of the range.
Finally, the Chaikin money flow volume, or the accumulation/distribution, is found by multiplying the money flow multiplier by the traded volume of the asset for the period.
The new accumulation/distribution line is obtained by adding the current period's money flow volume to the existing accumulation/distribution line.
The Chaikin Oscillator is born
Don't worry about the calculations, however. Capital.com does all of this for you and the Chaikin Oscillator of any of the assets we trade can easily be charted at the click of a button on our CFD trading platform.
This oscillator was named after its creator Marc Chaikin, a former stock broker and founder of Chaikin Analytics, who believes traded volumes form an integral part of the internal dynamics of any given market.
Chaikin says: "Volume analysis helps in identifying internal strengths and weaknesses that exist under the cover of price action."
For many years it was accepted wisdom that volume and price rose and fell simultaneously. But price action often lags changes in volume momentum, and identifying the point at which significant changes in volume occur before the price has reacted is a valuable tool.
Chaikin's Oscillator, then, is finally measured by taking the difference between the three-day EMA of the MACD's accumulation/distribution line and the 10-day EMA of the MACD's accumulation/distribution line.
Chaikin's three premises
"The premise behind my oscillator is threefold," Chaikin says:
- If an asset price closes above its midpoint for the day (as defined by [high + low] / 2), then there was accumulation on that day. The closer a stock or average closes to its high, the more accumulation there was. Conversely, if a stock closes below its midpoint for the day, there was distribution on that day. The closer a stock closes to its low, the more distribution there was
- A healthy advance is accompanied by rising volume and a strong volume accumulation. Since volume is the fuel that powers rallies, it follows that lagging volume on rallies is a sign of less fuel available to move stocks higher
- By using the Chaikin Oscillator, you can monitor the flow of volume into and out of the market. Comparing this flow to price action can help identify tops and bottoms, both short-term and intermediate-term
The oscillator in action
Take a look at the chart below of the price action between the euro and the dollar.
At point 1 on the bottom section, the oscillator indicates rising volume momentum as it passes through the zero mark. This is a buy signal, confirmed by the price action that begins at the corresponding point 1 on the upper section.
Soon after there are two dips followed by peaks of decreasing weight – the red line indicated at point 2 on the oscillator. This is a sell signal, confirmed by the fall at point 2 on the eur/usd chart.
Finally - the last confirmed signal on this chart shows the oscillator again coming from a trough and passing through the zero line to give a strong buy signal at point 3 on the chart.
Although the oscillator, after the triple peak sequence at point 3, falls off sharply – indicating a sell signal – the actual fall in price is not as dramatic as the oscillator suggests.
Chaikin oscillator trading strategy
An investment strategy based on indications given by the Chaikin oscillator can work well – the evidence is in the above chart. It has its limitations, however, and can – as can any form of technical analysis – occasionally generate misleading signals.
This is why all technical analysts would advise looking at the various indicators in conjunction with other tools. A pairing of the Chaikin and Stochastic oscillators, perhaps, might work well. It's up to the individual investor to find out what works well for them.
Here's what Chaikin himself said on this: "Since no technical approach works all the time, I suggest using the oscillator along with other technical indicators to avoid problems. I favour using a price envelope around a 21-day moving average and an overbought/oversold oscillator together with the Chaikin Oscillator for the best short and intermediate-term technical signals."