The trading market never operates without the involvement of a certain degree of risk. Prices of securities and instruments move constantly. Some securities are riskier than others as they are more volatile. Volatility is used to define constant price movement where the prices can go up and down and come back again. Cryptocurrency is considered one of the most volatile investments. Volatility scares new traders away, but veterans know how to use it for their benefit. With the help of a good volatility indicator, they can strategize more accurately and make a profit. One such indicator is the Choppiness Index.
What is Choppiness Index?
Choppiness Index represents an indicator developed by an Australian commodity trader Bill Dreiss that determines how much market trading sideways or trading within a trend. Choppiness Index uses a scale from 1 – 100 where the choppy market is over 61.80 and the trending market is below 38.20.
Developed by an Australian commodity trader, Bill Dreiss, the Choppiness Index is touted as one of the best volatility indicators. It was designed to highlight the trends of the market solely. It was not to be used to predict any price direction. It was named si because its developer wanted this indicator to determine the choppy (ranging) or not choppy (trending).
Traders can know about the strength of a trend by reading the choppy scale between 0 and 100. The higher values stand for consolidation, while the lower values depict strong trends (directional trending).
How to use Choppiness Index in Trading?
To trade using the choppiness index indicator, you need to analyze trend strength using higher, lower, and midline thresholds.
It is effortless to set the Choppiness Index and use it to find trading signals. Though it’s default setting is of 14 days, you can easily customize it. For example, fibonacci values are usually used as extremes when the market is trendy or choppy.
Once you have customized the days, you need to look at the scale to identify the signals. These signals will be between zero to a hundred. The scale is divided into three parts:
- The Higher Threshold: If the scale’s value is above 61.8, it is considered the higher threshold. It indicates consolidation in the market.
- The Lower Threshold: If the value on the scale is less than 38.2, it is considered the lower threshold. It shows strong signals. This means that the market has strong trends.
- The Midline: This index is used to measure the current trend status. If the value on the scale is above 50, you can expect trends to remain choppy. On the contrary, if the value is below 50, the market trends tend to persist. This proves that the Choppiness Index lags in conveying the information about the actual trend.
How to Create Trading Strategies Using the Choppiness Index?
Note that a solitary indicator, tool, or oscillator cannot assist you in creating a strong trading strategy. You have to use every supporting tool in combinations. Here, we use the Choppiness Index with the ADX (Average Directional Index) and the RSI (Relative Strength Index) to generate trading signals. We can expect these three to give us comprehensive buy and sell signals.
Buy signals are generated when the following takes place:
- The Relative Strength Index is more than 60.
- The Choppiness Index closes below 38.2 (lower threshold).
- The Average Directional Index cuts 20 levels from beneath.
You can see all of the above happenings in the graph given below. There is a strong upside rally because all of the above points are taking place simultaneously.
Sell signals are generated when the following takes place.
- The Relative Strength Index is more than 40.
- The Choppiness Index closes once more below 38.2 (lower threshold).
- The Average Directional Index against cuts 20 levels from beneath.
The only change taking place here is caused by RSI. Look at the following graph to see a strong all of the stocks of Religare Enterprises.
While it is great at measuring the current trends, the same cannot be said when it comes to actual trends. The Choppiness Index makes it easier for traders and investors to ranges and market trends. It is definitely an interesting tool to have on your trading platform.
We will not advise you to use this or any other tool in isolation. However, when combined with other tools, it helps you in identifying different types of signals. If you are new to using the Choppiness Index, start with paper or a small investment.