The Chaikin oscillator measures the money moving in and out of a given security. In practice, the oscillator is the accumulation distribution of the moving-average-convergence-divergence (MACD) indicator.
As a momentum indicator, the Chaikin oscillator helps to measure the momentum generated by oscillations of the accumulation and distribution line.
Using the Chaikin oscillator confers certain benefits. The line is a visual representation between the buyers and sellers in a given marketplace. Thus, when the line turns above the zero line, it is said that buyers are in control, while a dip below the zero line indicates that sellers have taken over.
As a leading indicator, knowing which way the momentum is heading can foreshadow a change in price direction.
- One way to use the oscillator is with divergences when attempting to predict a change in the price trend. For example, if prices are making higher highs while the oscillator is trending lower, this may indicate that a change is about to take place in the overall trend due to a bearish divergence.
- Conversely, a bullish divergence is when prices make lower lows while the Chaikin oscillator moves above the zero line to the positive.
At its core, the Chaikin oscillator illustrates the theory of accumulation and distribution. During periods of accumulation, educated ‘smart money,’ or ‘strong hands’ buys the security, which leads to higher prices and price velocity. Once the period of accumulation reaches its peak, the market then moves to a form of distribution, which is when the smart, educated investors sell off their positions to lock in a profit.
The distribution of profits kicks off a new downward trend, as money is changed from the strong hands to the weak. Speculative, less-informed investors tend to buy near the top at market cycles as strong hands exit the market.
This theory of accumulation and distribution is what the Chaikin oscillator and other momentum and money flow-based oscillators are based on.