How to Use the Chaikin Oscillator in Trading
The Chaikin Oscillator is a powerful momentum indicator that can help traders uncover hidden trading opportunities and spot emerging trends. In this article, we’ll delve into its inner workings, explore how to interpret its signals and show you how it can be applied.
What Is the Chaikin Oscillator?
The Chaikin Oscillator, developed by Marc Chaikin, is a momentum indicator designed to assist traders in identifying trends and predicting potential price movements. It combines the accumulation/distribution (A/D) indicator – a well-known Chaikin volume indicator – with the moving average convergence divergence (MACD) formula to demonstrate money flow in or out of an asset.
Definition and Characteristics
At the heart of the Chaikin Oscillator is the A/D line, which uses an asset’s closing price relative to its high-low range, weighted by its volume, to determine whether an asset is being accumulated (bullish) or distributed (bearish). Like MACD, the Chaikin Oscillator measures the distance between two moving averages. However, instead of closing prices, the Chaikin Oscillator is calculated using two exponential moving averages (EMAs) of the A/D line, typically 3 and 10.
The resulting indicator oscillates above and below a zero line. Positive values indicate buying pressure or accumulation, while negative values suggest selling pressure or distribution. In other words, when the faster EMA moves above the slower EMA, the oscillator will turn positive. When the faster EMA crosses below the slower EMA, it’ll read negative.
How the Chaikin Oscillator Is Calculated
The calculation of the Chaikin Oscillator is a multi-step process that begins with determining the accumulation/distribution line. To calculate A/D, we first need to find the money flow multiplier (MFM), which is found using the following formula:
MFM = ((Close - Low) - (High - Close)) / (High - Low)
Next, we multiply the MFM by the volume for the period to obtain the money flow volume (MFV):
MFV = MFM x Volume
The ADL is then calculated cumulatively by cumulatively the MFV values over a given period:
ADL = Previous ADL + Current MFV
Finally, the Chaikin Oscillator is derived by subtracting a longer-term EMA of the ADL from a shorter-term EMA of the ADL. Using the default Chaikin Oscillator settings of a fast 3-period EMA and slow 10-period EMA would mean:
Chaikin Oscillator = (3-day EMA of ADL) - (10-day EMA of ADL)
Interpreting the Chaikin Oscillator Indicator
There are three primary ways to interpret the Chaikin Oscillator: centre crossovers, divergences, and trend confirmation. Let’s take a look at each.
Centreline Crossovers
As discussed, a move above the zero line indicates that buying pressure is taking over and usually precedes further bullishness. Conversely, a bearish signal occurs when the oscillator crosses below the zero line, suggesting selling pressure.
Divergences
Divergences occur when the price of an asset moves in the opposite direction of the Chaikin Oscillator. A bullish divergence is seen when price hits a new low, but the oscillator forms a higher low. Likewise, a bearish divergence is where price makes a higher high, but the oscillator shows a lower high. In both scenarios, traders can anticipate a potential trend reversal.
Trend Confirmation
Lastly, the Chaikin Oscillator can be used to confirm the direction of the prevailing trend identified with other technical analysis tools. If the oscillator is consistently above the zero line during an uptrend, it signals buying pressure and vice versa.
Want to try your hand at interpreting the indicator for yourself? Try our free TickTrader platform at FXOpen, where you’ll find the Chaikin Oscillator alongside dozens of other indicators and tools.
How to Use the Chaikin Oscillator: an Example
The nature of the Chaikin Oscillator means that it frequently fluctuates above and below the zero line, which can generate plenty of false signals. However, many traders get around this by using the centreline crossover as an entry signal following a divergence. As an additional filter, we can look to enter when a divergence occurs at an area of support/resistance.
In the chart shown, we’ve identified three potential support and resistance areas. When price enters these areas, we can begin to look for divergences. Then, when the oscillator moves above or below 0 and confirms the divergence, we can make an entry. The theory says stops can be placed above or below the relevant support/resistance level, while profits can be taken at an opposing support/resistance.
For best results, you can look for obvious divergences that stand out. While smaller divergences can work, they’re often less reliable.
Limitations of the Chaikin Oscillator
While the Chaikin Oscillator is a valuable tool, it has limitations. The first is that its interpretation can be confusing without strict entry criteria in place. As in the chart above, there are many times when the oscillator fluctuates above and below 0, despite the broader trend being bearish. While this can be mitigated by using higher periods, like 10 and 50, it can still easily throw up false signals when used in isolation.
The second is a broader limitation of the A/D indicator. Since A/D relies on volume and price movements, assets with low liquidity or erratic price action can make interpreting the oscillator tricky. The simple answer here is to trade liquid, stable markets. However, in scenarios where you are trading these less liquid and volatile markets, you may need to employ other technical analysis tools.
Your Next Steps
Ready to create your own Chaikin Oscillator trading strategy? You can apply the example above in TickTrader and see how it works for yourself. Once you’ve backtested a few setups and got to grips with the strategy, you may want to open an FXOpen account. With low trading costs, ultra-fast execution speeds, and over 600 markets to choose from, you can rest assured you’re partnering with a trusted broker. Good luck!
This article represents the opinion of the Companies operating under the FXOpen brand only. It is not to be construed as an offer, solicitation, or recommendation with respect to products and services provided by the Companies operating under the FXOpen brand, nor is it to be considered financial advice.
What Is the Chaikin Oscillator?
The Chaikin Oscillator, developed by Marc Chaikin, is a momentum indicator designed to assist traders in identifying trends and predicting potential price movements. It combines the accumulation/distribution (A/D) indicator – a well-known Chaikin volume indicator – with the moving average convergence divergence (MACD) formula to demonstrate money flow in or out of an asset.
Definition and Characteristics
At the heart of the Chaikin Oscillator is the A/D line, which uses an asset’s closing price relative to its high-low range, weighted by its volume, to determine whether an asset is being accumulated (bullish) or distributed (bearish). Like MACD, the Chaikin Oscillator measures the distance between two moving averages. However, instead of closing prices, the Chaikin Oscillator is calculated using two exponential moving averages (EMAs) of the A/D line, typically 3 and 10.
The resulting indicator oscillates above and below a zero line. Positive values indicate buying pressure or accumulation, while negative values suggest selling pressure or distribution. In other words, when the faster EMA moves above the slower EMA, the oscillator will turn positive. When the faster EMA crosses below the slower EMA, it’ll read negative.
How the Chaikin Oscillator Is Calculated
The calculation of the Chaikin Oscillator is a multi-step process that begins with determining the accumulation/distribution line. To calculate A/D, we first need to find the money flow multiplier (MFM), which is found using the following formula:
MFM = ((Close - Low) - (High - Close)) / (High - Low)
Next, we multiply the MFM by the volume for the period to obtain the money flow volume (MFV):
MFV = MFM x Volume
The ADL is then calculated cumulatively by cumulatively the MFV values over a given period:
ADL = Previous ADL + Current MFV
Finally, the Chaikin Oscillator is derived by subtracting a longer-term EMA of the ADL from a shorter-term EMA of the ADL. Using the default Chaikin Oscillator settings of a fast 3-period EMA and slow 10-period EMA would mean:
Chaikin Oscillator = (3-day EMA of ADL) - (10-day EMA of ADL)
Interpreting the Chaikin Oscillator Indicator
There are three primary ways to interpret the Chaikin Oscillator: centre crossovers, divergences, and trend confirmation. Let’s take a look at each.
Centreline Crossovers
As discussed, a move above the zero line indicates that buying pressure is taking over and usually precedes further bullishness. Conversely, a bearish signal occurs when the oscillator crosses below the zero line, suggesting selling pressure.
Divergences
Divergences occur when the price of an asset moves in the opposite direction of the Chaikin Oscillator. A bullish divergence is seen when price hits a new low, but the oscillator forms a higher low. Likewise, a bearish divergence is where price makes a higher high, but the oscillator shows a lower high. In both scenarios, traders can anticipate a potential trend reversal.
Trend Confirmation
Lastly, the Chaikin Oscillator can be used to confirm the direction of the prevailing trend identified with other technical analysis tools. If the oscillator is consistently above the zero line during an uptrend, it signals buying pressure and vice versa.
Want to try your hand at interpreting the indicator for yourself? Try our free TickTrader platform at FXOpen, where you’ll find the Chaikin Oscillator alongside dozens of other indicators and tools.
How to Use the Chaikin Oscillator: an Example
The nature of the Chaikin Oscillator means that it frequently fluctuates above and below the zero line, which can generate plenty of false signals. However, many traders get around this by using the centreline crossover as an entry signal following a divergence. As an additional filter, we can look to enter when a divergence occurs at an area of support/resistance.
In the chart shown, we’ve identified three potential support and resistance areas. When price enters these areas, we can begin to look for divergences. Then, when the oscillator moves above or below 0 and confirms the divergence, we can make an entry. The theory says stops can be placed above or below the relevant support/resistance level, while profits can be taken at an opposing support/resistance.
For best results, you can look for obvious divergences that stand out. While smaller divergences can work, they’re often less reliable.
Limitations of the Chaikin Oscillator
While the Chaikin Oscillator is a valuable tool, it has limitations. The first is that its interpretation can be confusing without strict entry criteria in place. As in the chart above, there are many times when the oscillator fluctuates above and below 0, despite the broader trend being bearish. While this can be mitigated by using higher periods, like 10 and 50, it can still easily throw up false signals when used in isolation.
The second is a broader limitation of the A/D indicator. Since A/D relies on volume and price movements, assets with low liquidity or erratic price action can make interpreting the oscillator tricky. The simple answer here is to trade liquid, stable markets. However, in scenarios where you are trading these less liquid and volatile markets, you may need to employ other technical analysis tools.
Your Next Steps
Ready to create your own Chaikin Oscillator trading strategy? You can apply the example above in TickTrader and see how it works for yourself. Once you’ve backtested a few setups and got to grips with the strategy, you may want to open an FXOpen account. With low trading costs, ultra-fast execution speeds, and over 600 markets to choose from, you can rest assured you’re partnering with a trusted broker. Good luck!
This article represents the opinion of the Companies operating under the FXOpen brand only. It is not to be construed as an offer, solicitation, or recommendation with respect to products and services provided by the Companies operating under the FXOpen brand, nor is it to be considered financial advice.
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