Indicator Toolbox – Choppiness Index

The original Analysis Toolbox articles discussed the various market cycles including trends and continuations. This part of the The Trader’s Indicator Series focuses on the Indicator Toolbox, as we will discuss various indicators that are found on most trading platforms. We will discuss the indicator in the context of the chosen market, and if it resonates with you, please continue to do your own analysis with it. Trading successfully is all about feeling comfortable with a methodology and using that system repeatedly even when boredom sets in. I will be discussing indicators in alphabetical order that can be found on the MotiveWave platform. (for a free 2-week trial CLICK HERE)

In the last series, called The Trader’s Pendulum, we took you through the 10 Habits, all aimed to support a successful trader. Your mission in developing these habits is to get out of the Technical Trader’s Trap and transform into an Entrepreneurial Trader so that you can start being accountable to your trading. We invited you to take action and begin your journey by completing the Trader’s Scorecard (www.fxtradersedge.com/scorecard) and to get down to business by arranging a free coaching session. In this Indicator Series, we talk about the mechanics of trading.

The Choppiness Index (CI) was authored by Australian commodity trader E.W. Dreiss. The CI may be used to determine if the market is consolidating or trending.

INTRODUCTION

The Choppiness Index (CI) is an indicator which attempts to distinguish between trending and sideways markets. Many indicators which determine trend are called directional indicators, meaning they show whether the market is in an uptrend or a downtrend. This indicator shows whether the market is trending or not, and that trend can be up or down; it doesn’t matter. It is up to the trader to use it to confirm their view of the market they are trading. With this indicator, higher values mean more choppiness, and lower values mean directional or trend trading. See the weekly S&P Index above and notice the trending areas in red and the choppy areas in blue.

The formula variables include the Average True Range over the past n candles, as well as the highest high over the past n candles. The values always fall within a certain range between 0 and 100. The closer the calculation is to 0, the stronger the market is trending. The thresholds used to determine trending or sideways are Fibonacci ratios. Any number above 61.8 signifies sideways or choppy markets, and any number below 38.2 identifies with a trending market, whether up or down. The upper zone is chop and the lower zone is trend.

This indicator is more of a confirmation, since it lags, then a leading indicator; nonetheless, it can be a useful, visual representation of the market cycle.

USING THE TOOL

To illustrate this tool, look at the 4-hour chart below of the S&P500 index. The 50 line is comparable to the zero line with most oscillators; a move above 50, in blue territory, is a move towards a sideways or choppy market, which is confirmed above 61.8. Similarly, a move below 50, in red territory, is a move towards a trending market, which is confirmed below 38.2. The crossing of the 50 mark can be used as a heads up. Identify the trend and chop areas in the 4-hour S&P chart below and notice how price responds within those red and blue histogram sections.

The Index can be used to anticipate changes in the market cycle. Typically, if the market is trading sideways for an extended period, it is usually followed by a trend move and is just a matter of time. Therefore, the 50 line becomes important as the first sign of a change in the market cycle from trend to sideways or from sideways to trend. The market alternates between trends and consolidations and traders can use this index on a smaller time frame to get into the trend on the bigger time frame. In this example, the trader can look at the strong trend on the weekly chart, and look to enter long on the 4-hour chart using the Choppiness Index.

We recommend using a top down approach to trading with the trend as we know that without that higher time frame perspective, it is very easy to get caught up with countertrend moves, and miss the real trend. The challenge is to identify whether the trend will continue or not so combining this indicator with Elliott Wave analysis may be quite useful. Additionally, using trendlines and chart patterns will help to confirm the overall view of the market being traded.

Learn how the Choppiness Index helps keep traders in the trend longer, also alerting traders when the market is sideways. Start incorporating the Choppiness Index into your chart set-up. Finally, use the Choppiness Index in developing trading strategies.

See you next week for another “C” indicator!

If your mission is to become a trader or investor who stays out of the Technical Trader’s Trap, then take the leap to grow into an entrepreneurial trader.

I created the FX Trader’s EDGE Coaching Program modelled after the “10 Habits of Successful Traders”, which is the title of my newly published book by Wiley.

The Trader’s Pendulum: The 10 Habits of Highly Successful Traders.  Copyright (c) 2015 by Jody Samuels.  This book and ebook is available at all bookstores, online booksellers, and from the Wiley web site at www.wiley.com.

 

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