Chaikin Oscillator is a technical indicator developed by Marc Chaikin to measure the momentum of the Accumulation Distribution Line using the formula for the MACD. Therefore, it is an indicator of an indicator. Chaikin Oscillator shows the difference between the 3-day EMA of the Accumulation Distribution Line and the 10-day EMA of Accumulation Distribution Line. Like any other momentum indicator, this indicator is designed to anticipate changes in direction, in this case the Accumulation Distribution Line, by measuring the momentum behind the moves. A change of momentum is the first step toward a market trend change. Therefore, this indicator can help to anticipate trend changes of the asset that is being analyzed.
The Chaikin Oscillator generates signals with the crosses above or below the zero level and with the divergences.
Calculation of the Chaikin Oscillator
The calculation of this indicator can be divided into 4 steps, the first three for the calculation of the ADL (Accumulation Distribution Line). First calculate the Money Flow Multiplier, second multiply this value by the volume of the session which produces the value of the Money Flow Volume. Third, we must calculate the cumulative value of the Money Flow Volume for the value of the ADL. Finally, we calculated the 3-day EMA of the ADL and the value obtained is subtracted from the value of the 10-day EMA of the ADL and then you get the value of the Chaikin Oscillator.
- Money Flow Multiplier = [(Close – Low) – (High – Close)] / (High – Low)
- Money Flow Volume = Money Flow Multiplier * Volume for the Period
- ADL = Previous ADL + Current Period’s Money Flow Volume
- Chaikin Oscillator = (3-day EMA of ADL) – (10-day EMA of ADL)
The ADL grows when the Money Flow Multiplier is positive and falls when the Money Flow Multiplier is negative. The Money Flow Multiplier is positive when the closing price of the session is in the top half of the maximum-minimum range of that session and it is negative where the closing price is in the bottom half. As a MACD Oscillator type, Chaikin Oscillator is positive when the 3-day EMA of the ADL is higher than the 10-day EMA, and vice versa, the Chaikin Oscillator is negative when the 3-day EMA of the ADL is lower than the 10- days EMA.
Interpretation of Chaikin Oscillator
First of all, remember that the Chaikin Oscillator is an indicator of an indicator, which measures the momentum of the Accumulation Distribution Line. To calculate this indicator, it takes at least three steps that will move it away from price action:
- Price and volume are used to calculate the ADL.
- EMAs are calculated for the ADL.
- The difference of these EMAs are calculated.
You could say that the Chaikin Oscillator is a third derivative of the price, so this will definitely make the action of the indicator and price action can often uncoordinated. In other words, Chaikin Oscillator indicator is designed to measure the pressure of the buying and selling momentum through the Accumulation Distribution Line.
A move toward positive territory indicates that the Accumulation Distribution Line is increasing its value and that buying pressure prevails over the selling pressure. On the contrary, a move into negative territory indicates that the Accumulation Distribution Line is falling and that selling pressure is stronger than the buying pressure. That is, the Chaikin Oscillator crossing the zero level is a sign to open a buy/sell position. However, we can anticipate the crossing of the Chaikin Oscillator and the zero level using the divergences that we will see later.
Measuring the buying and selling pressure
Chaikin Oscillator can be used to determine the general situations of the buying and selling conditions in the market just by seeing if it has a positive or negative value. In general, the buying pressure is stronger when Chaikin Oscillator is positive and the selling pressure is strongest when it is negative.
The default configuration of the Chaikin Oscillator (10, 3) which is referred to the used EMAs, produce very frequently crosses with the zero, which can lead to open trading positions based on many false signals. So we can smooth the Chaikin Oscillator behavior increasing these values by default. For example, we can use the configuration (20, 6) shown in the following image:
In addition, trend lines can be applied to this indicator to better see the general trend of the indicator. A Chaikin oscillator that maintain a rising trend is indicative of a steady increase in buying pressure. Also, the breakdown of these trend lines applied to the Chaikin Oscillator often occur before the zero-line crossing and can be an early signal to close all open positions (rather than the opening). For example:
Chaikin Oscillator divergences
The divergences, whether bullish or bearish, are a clear signal for a possible change in the buy/sell precision momentum that can be used to predict a reversal in the price trend. A bullish divergence is formed when the price moves to new lows successively smaller (lower lows) and the Chaikin Oscillator form new lows successively larger (higher lows). These Higher lows show that the selling pressure is decreasing and that a change in the trend could be produced very soon. In a similar way can be described a bearish divergence which is formed when the price moves to new increasing highs (higher highs) while the Chaikin Oscillator form new highs successively lower (lower highs). It is advisable to confirm these trend reversal signals given by these divergences with other analysis tools and concepts such as support/resistance breakouts or with the change in Chaikin Oscillator from the positive area to negative area or vice versa.
Numerous divergences can be produced with the default configuration of the Chaikin Oscillator, the key is to learn and be trained to distinguish the significant divergences.
