Chaikin Volatility

Advertisement

Introduction

In 1966, stockbroker Marc Chaikin commenced his career on Wall Street. Successful and bright, he started to look into technical analysis as an alternative to fundamental research. He was the one that came up with several financial indicators that nowadays took his name. Now famous, the Chaikin Oscillator, the Chaikin Accumulation/Distribution indicator, the Chaikin Persistence of Money Flow indicator and the Chaikin Volatility indicator are used by traders across the world to analyze and forecast market movements.

Essential assumptions

The Chaikin Volatility Indicator (CVI) is helpful in determining the value extent between high and low prices on a certain period of time. It measures the volatility of a market which means it shows the predictability percentage of that market. Different from the Average True Range, the CVI does not take into considerations the trading gaps.

In general, Chaikin Volatility Indicator is used in conjunction with a moving average system and on a given period of time, commonly 10 days.

Trading Signals

In trading, the Chaikin Volatility indicator is used to quantify the degree of certitude about the next market progression. Calculated as the percent change in a moving average of the high versus low price over a given time, the CVI may forecast a market top and a bottom. As the indicator increases in value, the market is highly volatile (uncertain, variable) and it could predict a market bottom. Contrarily, as the CVI decreases and it ranges a narrow band, the market is said to be less volatile, more secure and prone to reach a top. A market bottom is reached when prices vary a lot from a short time period to another (hours, days) and people become anxious and begin to sell securities. The market top is a secure and flourishing moment with high prices (or a price explosion expected), also which follows a bull market and is determined over a longer time period by the high CVI.

Advertisement

Calculation

Similar to other indicators researched by Marc Chaikin, the Volatility indicator is easy to calculate using a formula. It is done like so:

Where:

CHV i – the Chaikin Volatility indicator;
EMA period – exponential moving average period (the number of bars of data, including the current value);
High i – the highest price value on the given time period;
Low i – the lowest security price on the given time period;
roc Period – the rate of change period (the number of bars of data to include in the percent change, not including the current value); and it’s multiplied by 100 to make the graph design easier.

First of all, a calculation of the EMA is made; the exponential price change (the difference between the highest and lowest price for each period), generally on a 10 day extent:

EMA period (High i – Low i)

Next, calculate the percentage change in the moving average over a further period with the given formula.

The 10 day time period is called a volatility smoothing period.

Interpretation

As the Chaikin Volatility indicator measures the instability of the stock market, its high values indicates that prices are changing fast and a lot during the day. Prices are constant when the indicator has low values. Basically, the flatter the CVI line on a graph, the more constant and secure the prices are.

A graphed market time period may have level prices or trendy prices. When a market is choppy, prices are variable and the market is insecure and contrarily, a trendy market tends to have an explosion/implosion of prices, following a trend – going up, or down. Both trendy and choppy markets can have high or low volatility on a certain time period, hence the 10 day generally used interval. This way, traders can better observe the true volatility of the market.

Sometimes, elevated volatility values are used in forecasting a trend reversal, such as a turning point in the market. Volatility peaks and abysses determine market tops and bottoms, points after which a new trend begins, be it upwards or downwards. Consequently, inferior volatility levels may be used to reflect the beginning of an upward price trend, which usually happens after a market consolidation period.

Conclusion

Although some traders believe that markets movements are random, there are several mathematical rules that apply. Stockbroker Marc Chaikin has used simple mathematics to find financial indicators that are helpful in forecasting market trends. With the Chaikin Volatility Indicator, traders everywhere may input data in a facile formula to calculate and estimate when markets reach tops and bottoms. The CVI is calculated by the recurrence of price movements (high vs. low) on a time period. As the indicator rises, so does the market volatility (can be triggered by massive security sales) which in turn triggers a chain reaction followed by a bear market, that in the end leads to a market bottom; as the CVI decreases and its line flattens, the market loses volatility and becomes more secure, ergo prices begin to increase, which consequently create a bull market, that usually leads to a market top.