Chaikin Volatility : an indicator of market instability

Among the various discoveries that we owe to Marc Chaikin, let's take a closer look at his Volatility Indicator.

An indicator that takes into account Exponential Moving Averages and the Rate of Price Change, Chaikin Volatility offers a simple and dynamic reading of overall financial market sentiment. Let's take a closer look at this tool, which is regularly used in technical analysis.  

What is the Chaikin Volatility indicator?

Named after its creator Marc Chaikin, the Chaikin Volatility Indicator is just one of the many tools designed by this technical analysis specialist. This Wall Street stockbroker also owes his fame to :

• the Chaikin Oscillator
• the Chaikin Distribution Accumulation Indicator
• the Chaikin Persistence Indicator

Now that the name is well anchored in your mind, let's focus on the objectives of the Volatility Indicator. The Volatility Indicator allows you to gauge the level of volatility of an asset by highlighting the differences between high and low prices on a stock. By carefully selecting a time period, the investor will have access to the percentage of predictability of the market in question. From there, it is up to them to position themself or not according to the state of the market and according to their risk aversion. The Chaikin Volatility Indicator can be applied both at the asset and financial market level. In all cases :

• High CVI indicates high volatility
• Low CVI indicates low volatility

The Chaikin Volatility Indicator can be implemented in several financial markets, such as :

• Stocks and bonds
• Stock market indexes, such as Nasdaq, CAC 40, DAX 30, S&P 500 or Dow Jones
• Raw materials
• The Foreign exchange market (FOREX)
• The cryptocurrency market (Bitcoin, Ethereum, Litecoin...)

Formula for calculating the Chaikin Volatility indicator

The Chaikin Volatility Indicator is relatively similar in formula to the ATR (Average True Range) Indicator, except that it does not take into account the previous day's closing price.

The formula for calculating the LCD is : LCD = (MME - (MMEp - P)) / (MMEp - P).

• MME is the Exponential Moving Average
• p is the selected calculation period
• P is the rate of change, over its own period

Exponential Moving Averages provide a percentage view of the volatility of the asset or market in question. This is then coupled with the subtraction of the lowest prices from the highest prices, referred to as the "rate of change over time P". 

The result of this calculation will range from -100% to 100% :

• -100% will illustrate zero market volatility (at time t)
• 100% will illustrate heightened market volatility
• The 0 will therefore be the equilibrium point meaning that the volatility remains stable

Note : to validate the calculation of this indicator, each of the following values must be distinct from the others:

• The price at the opening
• Closing price
• Highest price
• Lowest price

Without four different stocks, the investor has to extend the P period in which they use the Chaikin Volatility Indicator.  

How to use the Chaikin Volatility indicator in trading

Setting the indicator

The ideal period for setting up the Chaikin Volatility Indicator ise 10 days. This time frame is recommended for both the calculation of the MME and the rate of change. Thus, you will usually find this indicator in the form of Chaikin Volatility Indicator (10,10).  

Please note : For the MME, the recommended period can be extended to 12 days.  

Interpretation of the indicator

Several cases can be distinguished in the interpretation of the Chaikin Volatility Indicator :

• The Indicator points to 100%. In this case, we can consider that the extent of the oscillations is very strong, and the instability of the market as well. These values can describe a reversal of trend already started, with an accentuated slope.
• The indicator points to -100%. The market is now in a dead calm. 

Caution : this flat calm may mean that resistance or support has been reached, implying a potential trend reversal.  

• The indicator is around 0%. The volatility of the stock price is therefore normal and it is more difficult to take a position serenely.

Good to know : the Chaikin Volatility Indicator is also analyzed over time. A flat and stable curve - regardless of its percentage value - indicates that the market is volatile. This makes it more predictable and more likely that you will take a position.  

Thus, this indicator has two axes of analysis: its relative position (between -100% and 100%), and its temporal position. According to Chaikin, the latter, if it were to stabilise over too long a period, would reflect a market reaching its stage of maturity (volatility falling for too long) or recovery (rising for too long).  

Trading Strategies Using the Chaikin Volatility Indicator

Because the Chaikin Volatility Indicator gives an idea of the volatility of a market over time, Swing Trading or Day Trading strategies are preferred. With this tool, the investor should avoid strategies involving quick decisions such as scalping.

This easy-to-use and instinctively readable indicator offers three main functions :

• Measuring the level of confidence in the market by analyzing the highs and lows (this is the aspect most used by traders)
• Position yourself according to the risk level of a security, based on your investor profile
• Anticipate trend reversals on the site (upper extreme moving back towards 0%)

Good to know : Chaikin's Volatility works well with Japanese candlesticks. A green candlestick combined with a peak in volatility represents a buy signal, the opposite will be taken as a sell signal.  

Conclusion

The Chaikin Volatility Indicator allows you to easily identify changes in the volatility of an asset. However, there are various ways to analyse a trend : for this reason, it is highly recommended to couple the CVI with one or more other technical analysis tools such as the Japanese Candlesticks, stochastics or the RSI.