Choppiness Index Indicator

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Choppiness Index Indicator

Choppiness Index is a technical indicator which helps you understand the momentum and trend of them market. So, basically, this indicator is two in one indicator. You would be making trading decisions based on the indicator you see in the indicator window. Choppiness index indicator works best when it is combined with moving averages. Moving average is necessary when trading with indicator because this indicator itself doesn’t give clear buy and sell signals. At most of the times this indicator can be confusing for the new traders. You will get good results when you use this indicator in a trending market.

When you install Choppiness Index in your trading platform, your chart should look like this:

Choppiness Index

Choppiness index consists of a channel and an oscillator which moves like a MACD signal line. The upper band of this indicator works as an overbought and the lower band works as a support zone. Therefore, when the yellow oscillator is around the lower band you should be looking for buying signals and when the yellow oscillator is around the upper band, you should be looking for short opportunities.

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Buying Conditions Using Choppiness Index.

  • Market should be up trending.
  • Markets should be bouncing from the latest support.
  • Yellow oscillator of Choppiness index indicator should be rising from the lower band.
  • Place your long position when above conditions are met.
  • Place your stop loss below the recent support.
  • Take your profit when yellow oscillator breaches below the lower band.

Selling Conditions Using Choppiness Index.

  • Market should be down trending.
  • Markets should be falling from the latest resistance.
  • Yellow oscillator of Choppiness index indicator should be falling from the upper band.
  • Place your short position when above conditions are met.
  • Place your stop loss above the recent swing high.
  • Take your profit when yellow oscillator breaches below the lower band.

Choppiness Index Indicator Trading Strategy

Choppiness Index indicator (CHOP), as the name suggests, was introduced to determine whether the market is choppy. That means it shows whether the market is range bound or whether the market is trending. It also shows, the market is following a particular trend in either direction.

What is Choppiness Index indicator?

Bill Dreiss, an Australian commodity trader, introduced this indicator. The indicator is not at all a directional indicator. Its values do not help to create any position in the market. Just like the ADX/DMS, this indicator also shows the present strength of the trend. No future price projection is possible through this indicator. Higher values of this indicator mean that market is within a tight range and thus it’s choppy, whereas lower values mean the market is following a definite trend. Zerodha Kite as well as a few other trading platforms are equipped with this technical indicator in their indicator library.

How to set up CHOP in Zerodha Kite?

  • In your MarketWatch first select your favorite stock or commodity.
  • Right click on the name and open its chart by selecting the graph icon.
  • Now select the Studies section and from there select Choppiness Index and click on it.
  • The indicator’s parameters window will open that shows its default parameters.
  • The default period is 14 and the default color is white and you can select to show zones. The upper zone default is 61.8 and lower zone default is 38.2.

In the same way the CHOP can be attached to Upstox Pro with similar kind of settings and parameters.

Choppiness Index Indicator Formula:

Choppiness Index Indicator Trading Strategy

#1 Basic Trading Strategy

  • High values of CHOP shows the market is range-bound.
  • Lower values of CHOP shows the market is following a definite trend.

By default, the upper threshold in the Choppiness Index indicator is set at 61.8 while the lower threshold is set at 38.2. So higher readings above the upper threshold denote a rangebound and choppy market. On the other hand, readings below the lower threshold denotes a directional market. You can use some other trend following indicator to trade the trends in a lower CHOP reading.

#2 Advanced Trading Strategy – Combining CHOP with other indicators

You can create a robust trading system combining CHOP with some other technical indicators. Here we will be using the Relative Strength Index or RSI.

Put a 14-period RSI on the same charts with the CHOP indicator on it. Draw a horizontal line at the 50 level of the RSI. When the CHOP is above 61.8 or in between the upper and lower limits, do nothing. When the CHOP is below 38.2, the lower threshold, take a trade according to the RSI. If the RSI is above 50 take a buy trade and in case the RSI is below 50 take a short sell trade. Keep a suitable stop loss or use some trailing stop method.

The exit strategy

You can stay on the trade till the RSI stays above overbought zone or stays below oversold zone. Here in the example, we entered a buy trade as RSI was above 50 and CHOP drops below 38.2. The RSI went above the overbought zone. We remained in the trade till the RSI maintained above the overbought zone on 70.

#3 Counter Trend Strategy

We can also trade counter trend using the 2-period RSI and CHOP. Rules are simple. When CHOP indicates a rangebound market, if 2-period RSI reaches one extreme we can take a counter trend trade. As the market is rangebound the RSI and the price both will revert to their means. Watch the example below. Hene CHOP was rangebound as it was quoting above 61.8. Now when the 2-period RSI dipped below 5 open up a buy order. Exit when the RSI-2 moved above 60 or 70. In the same way a counter trend short sell trade can be taken.

Conclusion

The basic usage of the Choppiness Index Indicator is to find out whether the market is trending or choppy. This indicator can be categorized in the same category of ADX/DMS indicator or the Aroon indicator as these indicators also identify a trending or non-trending market. The indicator does not show the direction of the market. We can use this indicator along with some trend following indicator to create a powerful trend following system.

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Author: Indrajit Mukherjee

Indrajit is a professional blogger and trading system developer. Amibroker expert, WordPress expert, SEO expert and stock market analyst.Trading since 2002, he has started the journey of StockManiacs.net on 2008. He follows Indian and world stock markets closely. View all posts by Indrajit Mukherjee

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Choppiness Index

Choppiness Index

This lesson will cover the following

  • Definition
  • Calculation
  • Interpretation

Designed by E.W. Dreiss, the Choppiness Index is used to help traders determine whether the market is moving in a distinct direction, or it is trading sideways. It is similar to the broadly known Average Directional Movement Index as they are both developed to gauge a trends strength and movement direction. However, some traders regard the Choppiness index as the superior indicator.

The Choppiness Index is an indicator which is not directional. It does not predict future market direction, rather reflects whether the market is choppy (trades sideway) or smooth (trending). The general way of interpreting this index is that higher values mean the market is choppy, while lower values equal directional movement.

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Its formula involves the following calculation:

Choppiness Index = 100 * LOG10(SUM(ATR(1),n) / (MaxHi(n) – MinLo(n))) / LOG10(n), where:

– n is the user-defined period length
– ATR(1) is the Average True Range (Period of 1)
– SUM(ATR(1), n) is the sum of the Average True Range over past n periods
– MaxHi(n) is the the highest high over the past n periods
– MinLo(n) is the lowest low over the past n periods

The results are displayed on a scale of 0 to 100. The closer the data is to 100, the choppier the market is, and vice versa. Default settings include Fibonacci-based upper and lower band of 61.8 and 38.2 respectively, which reflect when a trend or trading range are becoming excessive.

The Choppiness Index does not reflect the markets movement direction, but instead shows whether a trend is strong or not (the closer the indexs value is to zero – the stronger the trend is). Conversely, the more heavily the market is consolidating, the closer the index will be to 100. The screenshot below illustrates the indicator in a trading software.

There are a couple of assumptions that stem from the numbers listed above. Because values above 61.8 are observed during tight trading ranges, as the index rises above the upper band, it suggests that the market might be in for a strong breakout in the near future after the recent periods of tight consolidation.

Conversely, because values below 38.2 occur during strong trends in either direction, the index falling below the lower band is often a sign that market momentum might begin to wane in the near future as the trend enters its exhaustion phase.

However, just like overbought and oversold levels in indicators such as the Relative Strength Index etc, you shouldnt base your decision-making entirely on the Choppiness index rising above 61.8 or dropping below 38.2, rather use it in conjunction with other indicators as a confirmation tool (for example Parabolic SAR).

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