Today we’re looking at the Chopperness Index. What is it exactly and how can we use it?
Read on to find out.
We all know that volatility is one of the most important pillars of the financial markets. In simple terms, volatility refers to the up and down movements of a financial asset.
The movements are due to several factors including demand and supply, sentiment, corporate action, greed and fear, etc.
The choppiness index is like a Volatility indicator which tells whether a market is uneasy or trading sideways, or whether the market is following a certain trend.
This index gives a trader confirmation of market conditions, although this indicator cannot be used to predict future prices, but it gives a good indication of current market conditions.
This index is between a range of 0-100 and values close to 100 indicate choppiness, while values close to 0 indicate a trending market.
When we are in the troubled phase it becomes difficult to predict which direction prices will move, so it is recommended that you hold on to the market until a clear direction of the market can be established.
This indicator has a plethora of uses from currency markets to commodities to stock markets.
The choppiness index uses fractal geometry concepts that make this index difficult to compute. The calculation is as follows: –
When analyzing the Choppiness Index, this is indicated by a line that falls between 0 and 100. There are two main thresholds of 61.8 and 38.2, when the line is above 61.8 the market is in a consolidation phase.
If the level drops below 38.2, it suggests that the current trend is likely to continue.
This indicator can be used on its own, but it is recommended to use it with other technical indicators such as the. to use Relative Strength Index (RSI) and Moving averages for more accurate predictions and avoid the chance of a false breakout.
The Choppiness Index is a great tool to use to analyze a trend or predict a breakout, it compliments others technical indicators really good and helping a trader make the most appropriate decisions.
Some examples of the analysis of this index are: –
In the graph above, we can see from the highlighted points that the Choppiness Index line is close to the 61.8 threshold, which indicates that the market is sideways or is in consolidation or is not trending.
We can see that the price is moving sideways over this particular period, which suggests that the market is choppy.
As mentioned earlier, this index can also be used to predict potential breakouts. An outbreak usually occurs when it has been in consolidation for a long time.
An example of an outbreak is given below: –
As we can see above, the market stock moves sideways when the choppiness line is above the midpoint of 50 and closer to the 61.8 threshold.
But when the line approaches the 38.2 level we notice that a trend is beginning and when the line approaches 0 it is a clear indication that the trend is getting stronger and is likely to continue for a while.
This indicator is very simple to understand and easy to use, although one disadvantage of this indicator is that it does not inform us if a trend is continuing or changing course.
This index is widely used by numerous traders to confirm market conditions. While this indicator is very useful, it does not always provide accurate results when used on its own.
Hence, combining its use with various other indicators results in a successful trade.
Disclaimer: The information above is for For educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are unfamiliar with exchange-traded options. All readers interested in this strategy should do their own research and seek advice from a licensed financial advisor.