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Thursday, March 4, 2010

Developed by Marc Chaikin, the Chaikin Money Flow oscillator is calculated from the daily readings of the Accumulation/Distribution Line. The basic premise behind the Accumulation Distribution Line is that the degree of buying or selling pressure can be determined by the location of the close relative to the high and low for the corresponding period (Closing Location Value). There is buying pressure when a stock
closes in the upper half of a period’s range and there is selling pressure when a stock closes in the lower half of the period’s trading range. The Closing Location Value multiplied by volume forms the Accumulation/Distribution Value for each period. (See our Chart School article for a detailed analysis of the Accumulation/Distribution Line.)
The CIEN chart details the breakdown of the daily Accumulation/Distribution Values and how they relate to Chaikin Money Flow. The formula for Chaikin Money Flow is the cumulative total of the Accumulation/Distribution Values for 21 periods divided by the cumulative total of volume for 21 periods. On the CIEN chart, the purple box encloses 21 days of Accumulation/Distribution Values. The total of these 21 days divided by the total for the 21 days of volume forms the value of Chaikin Money Flow at the end of that day (purple arrow). To calculate the next day, the Accumulation/Distribution Value from the first day is removed and the value for the next day is entered into the equation.
The number of periods can be changed to best suit a particular security and timeframe. The 21-day Chaikin Money Flow is a good representation of the buying and selling pressure for the past month. A month is long enough to filter out the random noise. By using a longer timeframe, the indicator will be less volatile and be less prone to whipsaws. For weekly and monthly charts, a shorter timeframe is usually suitable. Generally speaking, Chaikin Money Flow is considered bullish when it is positive and bearish when it is negative. The next item to assess is the length of time Chaikin Money Flow has remained positive or negative. Even though divergences are not an intricate part of the strategy behind Chaikin Money Flow, the absolute level and general direction of the oscillator can be important.
Accumulation Indications
The Chaikin Money Flow oscillator generates bullish signals by indicating that a security is under accumulation. There are three items that determine if a security is under accumulation and the strength of the accumulation.
1.  The first and most obvious signal to look for: is Chaikin Money Flow greater than zero? It is an indication of buying pressure and accumulation when the indicator is positive
2.  The second item: determine how long the oscillator has been able to remain above zero. The longer the oscillator remains above zero, the more evidence there is that the security is under sustained accumulation. Extended periods of accumulation or buying pressure are bullish and indicate that sentiment towards the security remains positive.
3.  The third indication: the actual level of the oscillator. Not only should the oscillator remain above zero, but it should also be able to increase and attain a certain level. The more positive the reading is, the more evidence of buying pressure and accumulation. There is such a thing as weak buying! This is usually a judgment call, based on prior levels for the oscillator.

On the chart for AA, Chaikin Money Flow actually strengthened while the stock continued to decline. For most of October, the stock traded flat while Chaikin Money Flow remained positive and continued to strengthen. The accumulation levels, as evidenced by Chaikin Money Flow, were very strong in October. The stock fell at the end of October and Chaikin Money Flow declined in November. When the stock fell, distribution levels never surpassed -.10, indicating that selling pressure was not that intense. In late November, the stock managed a comeback and broke resistance at 64.
Chaikin Money Flow formed a higher low and returned to positive territory to confirm the breakout. Selling pressure dried up quickly and Chaikin Money Flow was able to bounce back in strong fashion. The evidence is clearly bullish, but to capitalize a trader would have had to act fast.

The chart for AOL is a bit different. The stock formed a double bottom in August and September while Chaikin Money Flow formed a rather large positive divergence. This divergence was not a signal, but would have served as an alert that the selling pressure was decreasing. Divergences can be difficult to act on and should be used in conjunction with other aspects of technical analysis. By the time the stock broke resistance at 52, Chaikin Money Flow has moved from a mildly bearish levels just above -.10 to moderately bullish levels just above +.13. The interesting point about AOL is the period from 28-Sept to 22-Oct (gray lines). During this period, the stock traded sideways, but Chaikin Money Flow continued to strengthen as buying pressure intensified. The oscillator moved from +.1208 on 28-Sept to +.2377 on 22-Oct. Buying pressure has nearly doubled. This was a clearly bullish indication and the stock soon obliged with an advance from the low fifties to over 90.
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J. Welles Wilder Jr. developed the Average Directional Index (ADX) in order to evaluate the strength of the current trend, be it up or down. It’s important to detemine whether the market is trending or trading (moving sideways), because certain indicators give more useful results depending on the market doing one or the other.ADX is an oscillator that fluctuates between 0 and 100. Even though the scale is from 0 to 100, readings above 60 are relatively rare. Low readings, below 20, indicate a weak trend and high readings, above 40, indicate a strong trend. The indicator does not grade the trend as bullish or bearish, but merely assesses the strength of the current trend. A reading above 40 can indicate a strong downtrend as well as a strong uptrend.ADX can also be used to identify potential changes in a market from trending to non-trending. When ADX begins to strengthen from below 20 and/or moves above 20, it is a sign that the trading range is ending and a trend could be developing.

When ADX begins to weaken from above 40 and/or moves below 40, it is a sign that the current trend is losing strength and a trading range could develop.

ADX is derived from two other indicators, also developed by Wilder, called the Positive Directional Indicator (sometimes written +DI) and the
Negative Directional Indicator (-DI).
More on ADX can be found in Wilder’s book, New Concepts In Technical Trading Systems, written in 1978. Wilder’s indicators remain some of the best and most popular indicators today.
Courtesy Copyright StockCharts.com .This content copyrights protected  Written by Arthur Hill.