Inspired by the prior work of Joe Granville and Larry Williams, Marc Chaikin developed a
new volume indicator, extending the work done by his predecessors. The Chaikin Oscillator
is a moving average oscillator based on the
Accumulation/Distribution indicator.
The following discussion of volume accumulation/distribution interpretation, written by
Marc Chaikin, is reprinted here with his permission:
"Technical analysis of both market averages and individual stocks must include
volume studies in order to give the technician a true picture of the internal
dynamics of a given market. Volume analysis helps in identifying internal
strengths and weaknesses that exist under the cover of price action. Very often,
volume divergences versus price movement are the only clues to an important
reversal that is about to take place. While volume has always been mentioned by
technicians as important, little effective volume work was done until Joe Granville
and Larry Williams began to look at volume versus price in the late 1960s in a more
creative way.
For many years it had been accepted that volume and price normally rose and fell
together, but when this relationship changed, the price action should be examined
for a possible change of trend. The Granville OBV concept which views the total
volume on an up day as accumulation and the total volume on a down day as
distribution is a decent one, but much too simplistic to be of value. The reason
is that there are too many important tops and bottoms, both short-term and
intermediate-term, where OBV confirms the price extreme. However, when an OBV line
gives a divergence signal versus a price extreme, it can be a valuable technical
signal and usually triggers a reversal in price.
Larry Williams took the OBV concept and improved on it. In order to determine
whether there was accumulation or distribution in the market or an individual
stock on a given day, Granville compared the closing price to the previous close,
whereas Williams compared the closing price to the opening price. He [Williams]
created a cumulative line by adding a percentage of total volume to the line if
the close was higher than the opening and, subtracting a percentage of the total
volume if the close was lower than its opening price. The
accumulation/distribution line improved results dramatically over the classic OBV
approach to volume divergences.
Williams then took this one step further in analyzing the Dow Jones Industrials
by creating an oscillator of the accumulation/distribution line for even better buy
and sell signals. In the early 1970s, however, the opening price for stocks was
eliminated from the daily newspaper and Williams' formula became difficult to
compute without many daily calls to a stockbroker with a quote machine. Because of
this void, I created the Chaikin Oscillator substituting the average price of the
day for Williams' opening and took the approach one step further by applying the
oscillator to stocks and commodities. The Chaikin Oscillator is an excellent tool
for generating buy and sell signals when its action is compared to price movement.
I believe it is a significant improvement over the work that preceded it.
The premise behind my oscillator is three-fold. The first premise is that if a
stock or market average closes above its midpoint for the day
(as defined by [high + low] / 2), then there was accumulation on that day. The
closer a stock or average closes to its high, the more accumulation there was.
Conversely, if a stock closes below its midpoint for the day, there was
distribution on that day. The closer a stock closes to its low, the more
distribution there was.
The second premise is that a healthy advance is accompanied by rising volume
and a strong volume accumulation. Since volume is the fuel that powers rallies, it
follows that lagging volume on rallies is a sign of less fuel available to move
stocks higher.
Conversely, declines are usually accompanied by low volume, but end with
panic-like liquidation on the part of institutional investors. Thus, we look for
a pickup in volume and then lower-lows on reduced volume with some accumulation
before a valid bottom can develop.
The third premise is that by using the Chaikin Oscillator, you can monitor the
flow of volume into and out of the market. Comparing this flow to price action can
help identify tops and bottoms, both short-term and intermediate-term.
Since no technical approach works all the time, I suggest using the oscillator
along with other technical indicators to avoid problems. I favor using a
price envelope around a 21-day moving average and an
overbought/oversold oscillator together with the Chaikin Oscillator for the best
short and intermediate-term technical signals.
The most important signal generated by the Chaikin Oscillator occurs when prices
reach a new high or new low for a swing, particularly at an overbought or oversold
level, and the oscillator fails to exceed its previous extreme reading and then
reverses direction.
Signals in the direction of the intermediate-term trend are more reliable than
those against the trend.
A confirmed high or low does not imply any further price action in that
direction. I view that as a non-event.
A second way to use the Chaikin Oscillator is to view a change of direction in
the oscillator as a buy or sell signal, but only in the direction of the trend.
For example, if we say that a stock that is above its 90-day moving average of
price is in an uptrend, then an upturn of the oscillator while in negative
territory would constitute a buy signal only if the stock were above its 90-day
moving average--not below it.
A downturn of the oscillator while in positive territory (above zero) would be a
sell signal if the stock were below its 90-day moving average of closing
prices."
The following chart shows Eastman Kodak and
the Chaikin Oscillator. Bearish divergences (where prices increased to new highs while the
Oscillator was falling) occurred at points "A" and "B." These divergences were warnings of
the sell-offs that followed.
The Chaikin Oscillator is created by subtracting a 10-period exponential moving average of
the Accumulation/Distribution Line from a 3-period
exponential moving average of the Accumulation/Distribution Line.
