Charts are not all uniform in their display with regard to time; sometimes there are uptrends or even downtrends, while also times when the market is sided, almost motionless or close to it. To each, traders must know whether and how to adapt to the shifts.
It would be much easier to trade if the market was either always trending or always range-bound. In a consistent trend, a well-suited strategy would involve following the trend. In a purely range-bound market, it would be very easy to trade the highs and lows of the range. The reality is that the market switches between these two states, so it is crucial to know when to employ mean-reversion strategies versus trend-following strategies.
Chopiness Index: What It Is and How to Use It
The Chopiness Index was designed to help traders identify how much the market is ranging or trending. It gives a numerical value showing the degree of market choppiness:
- High Value: The implication, therefore, would be sideways movement, as it suggests the market is very choppy.
- Low Value: The trending market is showing good directional movement.
How to Read the Choppiness Index:
- Peak Values: If the index reaches its peak and then starts downward, it suggests that a transition from a choppy state to a trending one is taking place in the market.
- Decreasing Values: These indicate that directional movement is reaching a higher level and may signal a trend.
- Low Values: While a low reading would indicate that the trend is strong, it could also mean it is exhausted, and the market may soon enter into a sideways phase.
The Trend in the Choppiness Index Itself:
One can take a lead if the Choppiness Index itself has been trending downward or pointing lower. That means it could be a sign of transition from range into trend. If it has gone upward, on the other hand, the market can change from a trend into a range.
Choosing the Right Length for the Choppiness Index
The Choppiness Index has a length setting, which dictates the time period it considers:
- Short Length: Reacts sooner, displays more current behavior.
- Long Length: Long length gives a wider look that allows for a longer-term view of market choppiness.
Chop Zone Indicator: Overview
Unlike the Choppiness Index, the Chop Zone Indicator represents market states with coloured columns:
- Blue: Indicates a strong uptrend.
- Red: Shows a strong downtrend.
- Intermediate Colors: These would include colors such as green, orange, and gray, which would indicate choppiness or a potential shift in market momentum.
How to Use the Chop Zone Indicator:
- Red to Blue Transition: This would mean transition from bearish into bullish.
- Blue to Red Transition: This transition indicates the shift from bullish to bearish conditions.
- Choppy Areas: When color changes occur more frequently, it serves as an indication of consolidation or indecision in the market—a period where the momentum is weak and one where false signals might be received with the use of trend indicators.
Combining Indicators
While the Choppiness Index will show how much a market is trending or ranging, the addition of the Chop Zone indicator adds in the layer of directional movement. These combined will better help the traders to decide more effectively where they should get into or out of a trade.
Custom Version of Chop Zone Indicator
I modified this Chop Zone Indicator version to set an input for the length, so you can broaden the period if you desire a broader view, shorten it if you need more narrow views. That certainly makes this modification very valuable for those people that wanted a bit more flexibility with regard to how an indicator was going to be used.
You can also plot the Chop Zone Indicator along with the Choppiness Index on the same chart for a complete view. This combination will enable the traders to:
- Determine the trend and choppiness level.
- Make informed decisions about when to trade or stay out of the market.
Conclusion
Identifying when not to trade is as important as identifying the direction in which the market is moving. In such a case, the Choppiness Index in combination with the Chop Zone Indicator will be very useful for the trader in determining whether the market is in a trending or range-bound scenario and thus conduct business appropriately. Remember, no indicator can ever be perfect; all together, they just refine the accuracy of your trade.
Pro Tip:
Experiment with the different settings and combinations that work best for your chart and trading style.