Volume Indicator MasterClass — Part 5

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Mudrex

8 min readJun 19, 2020

Chaikin Accumulation/Distribution Oscillator

In the last article of our MasterClass on Volume Indicators, we talked about the MFI volume indicator which closely resembled the RSI price indicator. Check the last article out if you haven’t already. In this article we’re going to talk about another very interesting volume indicator, the Chaikin Accumulation/Distribution Oscillator, which closely resembles the MACD price indicator. We’re gonna discuss the following topics in detail with description on charts wherever necessary. Towards the end, we will also give a step-by-step guide on how to make your own Chaikin Oscillator auto-trading bot with code on Mudrex.

Introduction
Accumulation/Distribution Line (ADL)
Chaikin Oscillator Calculation and Equations
Interpretation
Centreline Crossover Strategy

Introduction

Developed by Marc Chaikin, the Chaikin Oscillator measures the momentum of the Accumulation Distribution Line using the MACD formula. (This makes it an indicator of an indicator.) The Chaikin Oscillator is the difference between the 3-day and 10-day EMAs of the Accumulation Distribution Line. Like other momentum indicators, this indicator is designed to anticipate directional changes in the Accumulation Distribution Line by measuring the momentum behind the movements. A momentum change is the first step to a trend change. Anticipating trend changes in the Accumulation Distribution Line can help chartists anticipate trend changes in the underlying security. The Chaikin Oscillator generates signals with crosses above/below the zero line. The range of Chaikin could lie in hundreds of millions. The only crossovers that matter are those with the zero line.

Accumulation/Distribution Line

Accumulation Distribution uses volume to confirm price trends or warn of weak movements that could result in a price reversal.

Accumulation: Volume is considered to be accumulated when the day’s close is higher than the previous day’s closing price. Thus the term “accumulation day”
Distribution: Volume is distributed when the day’s close is lower than the previous day’s closing price. Many traders use the term “distribution day”

Accumulation/Distribution Phases in Market Cycles

Therefore, when a day is an accumulation day, the day’s volume is added to the previous day’s Accumulation Distribution Line. Similarly, when a day is a distribution day, the day’s volume is subtracted from the previous day’s Accumulation Distribution Line.

Calculation

First and foremost, it is important to remember that the Chaikin Oscillator is an indicator of an indicator, measuring momentum for the Accumulation Distribution Line. This makes it at least three steps removed from the price of the underlying security. First, price and volume are reshaped into the Accumulation Distribution Line. Second, exponential moving averages are applied to the Accumulation Distribution Line. Third, the difference between the moving averages is used to form the Chaikin Oscillator. As the third derivative, the indicator is more prone to disconnect from the price of the underlying security.

The key to understanding and using the Chaikin Oscillator effectively is to understand the essence of each of its components which are as follows-

Money Flow Multiplier = [(Close — Low) — (High — Close)] / (High — Low)

The Money Flow Multiplier fluctuates between +1 and -1. As such, it holds the key to the Money Flow Volume and the Accumulation Distribution Line. The multiplier is positive when the close is in the upper half of the high-low range and negative when in the lower half. This makes sense, as buying pressure is stronger than selling pressure when prices close in the upper half of the period’s range (and vice versa). The Accumulation Distribution Line rises when the multiplier is positive and falls when the multiplier is negative.

2. Money Flow Volume = Traded Volume x Money Flow Multiplier

The multiplier adjusts the amount of volume that ends up in the Money Flow Volume. Volume is in effect reduced unless the Money Flow Multiplier is at its extremes (+1 or -1). The multiplier is +1 when the close is on the high and -1 when the close is on the low. All volume is positive when +1 and all volume is negative when -1. At .50, only half of the volume translates into the period’s Money Flow Volume.

3. A/D Line = Previous ADL + Current Money Flow Volume

The ADL is a cumulative measure of each period’s volume flow, or money flow. A high positive multiplier combined with high volume shows strong buying pressure that pushes the indicator higher. Conversely, a low negative number combined with high volume reflects strong selling pressure that pushes the indicator lower.

4. Chaikin Oscillator = (3-Day EMA of ADL) — (10-Day EMA of ADL)

As a MACD-type oscillator, the Chaikin Oscillator turns positive when the faster 3-day EMA moves above the slower 10-day EMA. Conversely, the indicator turns negative when the 3-day EMA moves below the 10-day EMA.

Chart showing effect of of closing range and traded volume on ADL

Interpretation

The indicator is designed to measure the momentum behind buying and selling pressure (Accumulation Distribution Line). A move of the Chaikin Oscillator into positive territory indicates that the Accumulation Distribution Line is rising and buying pressure prevails. A move into negative territory indicates that the Accumulation Distribution Line is falling and selling pressure prevails.

The Chaikin Oscillator can be used to define a general buying or selling bias simply with positive or negative values. The indicator oscillates above/below the zero line. Generally, buying pressure is stronger when the indicator is positive and selling pressure is stronger when the indicator is negative.

As iterated innumerable times before, the fast-moving 3-period EMA closely follows ADL whereas the slower 10-period EMA follows the overall trend of the ADL. When the 3-period EMA moves above the 10-period EMA, it means that the ADL is rising and buying pressure is accumulating. This may be a good time to enter a trade as a trend reversal (Chaikin oscillator moving from negative to positive territory) is anticipated. Similarly, when the 3-period EMA moves below the 10-period EMA, it means that the ADL is falling and selling pressure is accumulating. This may be a good time to exit a trade as a trend reversal (Chaikin oscillator moving from positive to negative territory) is anticipated.

Hence, the centerline crossover strategy, like that of MACD is such that-

Buy when: Chaikin crosses up zero
Sell when: Chaikin crossing down zero

Building on Mudrex

When you build the strategy keeping the default look-back periods of 3–10, you’ll realise that the number of trades are very high, a lot of them being false. This is because, 3–10 is a very small look-back period for EMA making the Chaikin indicator oscillate about 0 quite frequently. To prevent frequent fluctuation and to smoothen out the indicator, the thresholds can be increased to two-fold i.e. 6–20, keeping the ratio the same while increasing the look-back periods of the shorter and longer period EMA of ADL. You can further increase the thresholds to 9–30 to generate even lesser, better quality trades.

The best thing about auto-trading bots is that you never have to worry about the calculation part of the technical indicators by yourself. Mudrex will do all the calculations for you and give out the Chaikin Oscillator line whose crossovers with the zero line can be used to generate buy/sell signals.

Indicator block for the buy condition of Chaikin crosses up zero:

Indicator block for the sell condition of Chaikin crosses down zero:

The overall strategy looks somewhat like this:

This is how easy it is to make your own auto-trading bot on Mudrex within minutes. A lot more interesting things can be done using the Chaikin Oscillator on Mudrex. In fact, since the final output of the oscillator closely resembles MACD, all crossover strategies of the MACD Line with other indicators are also applicable to the Chaikin Oscillator.

We can now run a quick backtest and analyse the trades generated on the candlestick chart for ourselves:

Two consecutive winning trades at zero-line crossover of Chaikin Oscillator

Look how the strategy generated a buy signal when the oscillator crossed up zero and generated the first sell signal when the markets became choppy. A subsequent uptrend led to the generation of the buy signal once more until the peak was reached which is when the oscillator crossed below zero and stayed in the negative territory thereafter.

The quality of trades over our discussion on volume indicators clearly shows how incorporating volume along with the price can be an important value add to the trading strategies. The use cases of all volume indicators closely resemble that of their analogous price indicators and thus innumerable trading strategies can be developed around them in combination with other price indicators.

One thing which is to be noted here is that, none of the strategies discussed till now are easy answers to market returns in any way. The strategies have been developed for experimental and educational purposes only, and can be worked upon and made better for better returns during live trades. Feel free to play around with them and develop your own trading strategies on Mudrex.

Checkout the rest of the articles if you haven’t already!

Part — 1: Introduction to Volume
Part — 2: On Balance Volume (OBV)
Part — 3: Volume Weighted Average Price (VWAP)
Part — 4: Money Flow Index (MFI)
Part — 5: Chaikin Accumulation/Distribution Oscillator (A/D)

Next up in our educational series is a MasterClass on Backtest Results where we’re going to talk about the different metrics on which a strategy can be judged and how to improve upon those metrics for better market returns. We will also be talking about various ways of risk management and insights on how to get rid of investor psychology while making your trading bots on Mudrex.

Stay tuned for the same!