When big investors are buying a stock, and are doing so aggressively, their demand should yieldhigher prices in the future, making the stock a wise investment.
In some respects, this is nothing more than Markets 101: examining supply and demand. Since price is a function of demand, it seems counter-intuitive to trackfluctuations in one element without paying attention to the other. This is where the Chaikin Oscillator comes in, examining both closing price and buying and selling pressure to determine the underlying demand for a stock.
The Chaikin Oscillator was invented by MarcChaikin, along-timestock trader and analyst whohas created dozens ofindicators duringhis distinguished career, with many of them nowstaples of Wall Street technical analysis. He devised the oscillator indicator as a way to measure the accumulation or distribution of a security by institutional investors, the ones who move markets.
Key Takeaways
- The Chaikin Oscillator examines both the strength of price moves and underlying buying and selling pressure.
- It provides a reading of the demand for a security, and possible turning points in the price.
- Divergence between price and the Chaikin Oscillator is the indicator’s most frequent signal, and often flags a short-term reversal in price.
How the Chaikin Oscillator Works
TheChaikinOscillator is essentially a momentum indicator, but of the Accumulation-Distribution line rather than mere price. It looks at both the strength of price moves and the underlying buying and selling pressure during a given time period.
A Chaikin Oscillator reading above zero indicates net buying pressure, while one below zero registers net selling pressure. The divergence between the indicator and pure price moves are the most common signals from the indicator, and often flag market turning points.
ChaikinOscillator Construction
The oscillator builds on the concept ofmoving average convergence divergenceor MACD.MACDis derived from themoving average, which isthe mean price of an issue over a certain period.
The transition from MACDto ChaikinOscillator requiresseveral steps. TheChaikinOscillator was created in reference to the accumulation/distribution,another Chaikin brainchild.Theacc/disline buildson the money flow multiplier,which attempts to quantify the amount of money coming into the market and its impact on stock prices.
The multiplier formula is as follows:f=(High−Low)[(Close−Low)−(High−Close)]
Let's say the stock in theprevious examplepeaked at $25 during the look-back period and then fell to$21. A day later, it closed at $22.Themoney flow multiplier, in this case, would be(25−21)[(22−21)−(25−22)]=−.5
Multiply that numberby the quantity of stocktraded over the period to get money flow volume, while the running totalgeneratestheacc/disline. The final step is to apply this outputto MACD.
Chaikin Devotees
What the oscillator lacks in simplicity, it makes up for in authority. By measuring the momentum of the accumulation/distribution line using theMACD model, the oscillator should anticipate when the line will change direction. By now, we're several levels removed from the stock price, butChaikindevotees argue that thedistance is neededto determine the importance of volume and price changes.
Also, three- and 10-day values aren't locked in stone. For example, swapping in six- and 20-day EMAswill result in aChaikinOscillator that changes direction less abruptly.
The Bottom Line
TheChaikinOscillator generatestechnical output thatsupports sound buy or sell decisions but is best used in conjunction with fundamentals and other indicators.
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