Choppiness is a range bound oscillator use to determine if the price activity being studied would be representative of a choppy market or trending market. Values for the oscillator are bound between the levels of 0 and 100. A value near 100 represents price action that is considered choppy. Values closer to 0 represent price action that is considered trending. The oscillator does not indicate the current direction of a trend, only the existence of a trend in current stock prices.
The system allows you to define an upper and lower band which is set to Fibonacci retracement levels of 61.8 and 38.2 by default. It is common for chart users to redefine those levels based on historically significant high and low levels of choppiness.
Choppiness in Practice
The Choppiness indicator will rarely reach a reading of 100 or 0 in most actively traded stocks. Therefore, the default settings help to identify a more common area of high or low levels of choppiness. In the example above, notice how the choppiness indicator was trending lower as the price was trending higher. This acts as a confirmation of an existing trend and confirms the usefulness of a trend following trading strategy. The second highlighted area is a high level of choppiness which coincides with stock prices being in a sideways or choppy period. Typically, sideways movement in a stock's price is indicative of a point of inflection. They often signal a pause in the current trend, but can also signal a reversal of the existing trend.
Traders that prefer to trade range bound stocks buying and selling the highs and lows would typically prefer a high level of choppiness. Traders that prefer a trend following strategy would prefer stocks with a low level of choppiness. For those traders that are flexible with the strategy it will assist in determining which types of strategies would be most useful in the current environment.
We added a 20 day moving average to the chart to show how a trend following tool performs during choppy market periods. In general, the average produced reasonable buy and sell signals, but during the high period of choppiness it gave a sell signal right before a gap up in price. It might have been better for a trader to monitor the support area of that sideways period as a sell signal rather than the simple strategy of selling when price falls below a moving average.
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The analytical tools described in this article are for information purposes only and their use does not guarantee a profit. None of the information provided should be considered a recommendation or endorsement of any specific investment, tool or strategy. The choice to engage in a specific investment, tool or strategy should be based solely on your research and evaluation of risks involved, your financial circumstances and investment objectives. Securities are subject to market fluctuation and may lose value. Market volatility, volume, and system availability may impact account access and trade execution.