Background: The Chaikin Volatility indicator is one of a number of indicators developed by Marc Chaikin. It quantifies volatility as a widening of the range between the high and the low price for a period but, unlike Average True Range, does not take account price gaps.
The indicator is calculated by taking an exponential moving average of the difference between high and low prices over a period of time, typically 10 days. Then a percent change is taken for the moving average over that period of time, similar to the calculation for the rate of change indicator (comparing today’s value with a value X days ago), and multiplied by 100 to provide an indicator reading.
Purpose: Like most volatility indicators, the intent of Chaikin Volatility is to get an early read on trend changes based on shifts in volatility before the change becomes evident in price activity. High values indicate that prices are changing a large amount during the day; low values indicate relatively constant prices.
Basic signals: Traders can interpret Chaikin Volatility readings several ways. In general, sharp increases in volatility tend to show up prior to market tops as traders become more nervous and indecisive. Low volatility levels may indicate investor boredom and can sometimes be used to time the beginning of new upward price trends following periods of consolidation.
Another method assumes that an increase in Chaikin Volatility reading over a short period of time indicates that a bottom is near due to panic selling whereas a decrease in volatility over a longer time period indicates a mature bull market and an approaching top.
Pro/con: As is typical with indicators, it is best not to rely only on one but to use a moving average crossover or band trading strategy to make a trading decision. Interpretations of Chaikin Volatility vary but, in general, it is the change in volatility that serves as a valuable tool for spotting possible trend reversals.
