To know about chaikin oscillator, first we need to learn about Accumulation/Distribution line which was also developed by chaikin.
Before that, let’s put a question ourselves. For instance, if you want to invest in a particular stock, which of the following cases would you prefer?
A. Stock rising gradually with reasonable volume for a certain period of time
B. Stock rising phenomenally with very less volume.
It’s obvious that we pick ‘A’ though the rise is comparatively less just because the volumes are good in the former case. Even institutional buying follows the same. This tells us that volumes play a vital role while picking up a stock.
This is where chaikin acted smart while all other dealt with price and time. He included volume in calculating Accumulation/Distribution line. Unlike other oscillators, chaikin’s line methodology takes price opening, closing and volume into consideration. First it calculates the Close Location Value (CLV) based on closing prices and multiplies that with volume to form an Accumulation/Divergence line.
CLV is calculated in the following manner:
If the stock price closes at the top of the candle, CLV is +1.
If it closed above the half of the candle and below the period high, it is given a value from 0 to 1
If the stock price closes exactly at half of the candle, it is rated as 0
If the stock value closes anywhere in between halfway and above the candle low, then it is calculated from 0 to -1
Lastly, if the closing price is at the bottom, the value is -1.
The values obtained from the above method are now multiplied with volumes to get Acc/Dist Line. Based on this, chaikin Oscillator is developed.
Just similar to MACD (discussing in the next chapters) which takes the difference between the moving averages of the prices, chaikins Oscillator too takes the difference of moving averages but of Acc/Dist line. Finally an oscillator with volume as an ingredient was done. Even if any intermediate rise occurs in the strong falling trend, this oscillator ignores that if the volume is less (which generally happens) and tends to show the down trend. So, traders who uses chaikin’s oscillator may not take volumes into consideration again as it is already included. This indicator has a zero line above which the trend is considered as positive and below which markets may experience bearish shower. Importantly, unlike other oscillators, the reading is also not constant and it differs with the volume and price.
Crossover of Zero Line
This is one of the most common applications used to trade. If the oscillator swings above the zero line, it is treated as a bull security and buying can be seen with good volumes. If the chaikin oscillator is below the zero line, sell trade can be initiated.
This application remains same as in the other oscillators. Above chart is the perfect example. If the markets move upside and oscillator shows a downward movement, a bearish divergence is said to occur and the stock is expected to fall from thereon. If the stock price fall and chaikin indicator moves up, we call that as a bullish divergence with a hope of security to move upside.