The Chaikin Volatility (CV) indicator was developed by stockbroker Mark Chaikin and is used in technical analysis to measure volatility (should be clear from the indicator's name). The volatility is measured by comparing the spread between high and low prices via Rate of Change (ROC) formula. The Chaikin Volatility indicator could be compared to ATR (Average True Range) with difference that it does not take into account previous bar close price (ignores gaps).
The CV indicator oscillated around zero (center) line in the range between -100% and 100% when low negative values are indication of low volatility and high positive readings indicate high volatility.
In technical analysis volatility has important and specific function. After using different technical indicators one could notice that the same indicator with the same settings over prolonged period of time may have moments when signals are generated too early, too late or at perfect time. Such indicator's behavior is a result of changes in volatility of analyzed security - security changes its trend faster and more often during periods of higher volatility and it tends to have slower and rarer trend changes during periods of low volatility. Furthermore, it could be recommended to keep an eye on volatility when technical indicators that do not carry volatility factor in their calculations are used and adjust your indicators' settings in accordance to the volatility charges.
At the same time, volatility could be used to generate trading signals. Higher volatility suggest unstable sentiment, nervous trading which is usually noted during the market crashes, recessions and downtrends. Lower volatility is usually associated with calm and confident trading which is a characteristic of an up-trend. After brief history scan, you may notice following trend-volatility dependence:
- When analyzed security is in down-trend, sharp increase in volatility during the short-period of time could be seen near the bottom of a down-trend (correction);
- Decrease in volatility and low volatility could be seen during up-move;
- Slow increase in volatility usually during side-way trading after up-move could be seen at the top of an up-trend and before a reversal down;
- Higher volatility could be seen during down-move.
Chart 1: DJI chart and Chaikin Volatility Indicator
The is calculated by applying ROC formula to the High-Low price range:
By V. K. for MarketVolume.com