SP500 Choppiness Index

The market does 3 main things: (1) Trend higher, (2) trend lower, and (3) do neither.  On different time frames, it can even do all three of those at the same time.  This week's chart looks at something called the Choppiness Index, which is a way of quantifying those behaviors.  It was developed by Australian commodities trader E.W. Driess. 

The point of the Choppiness Index is to assign a numerical score for how the recent data have been displaying trending behavior, or not.  A low reading means that the recent trend has been very linear, although it does not say anything about which direction that trend has traveled.  The implication of a low reading is that a non-trending period ought to commence.

A high reading says that the recent price data have been very trendless, and thus that a new trending period should follow.  But this indicator says nothing about which direction that new supposed trend should go, only that there should be one. 

One might reasonably ask what good it is to have an indicator that does not tell you anything about price direction.  The answer is that it tells us about trending or trendless behavior, and those behaviors tend to last only so long.  So when you see the Choppiness Index get to an extreme reading, the message is that a change in behavior is coming.  It is then left to the chartist to interpret what behavior it is that will be changing, and what that change would mean for price behavior. 

When there is a high reading like we see right now, the message is that a trending move ought to commence.  But which way?  There are fortunately multiple tools that chartists can use to detect the direction of price movement.  The Choppiness Index just says, "start looking!"

To calculate a 14-day Choppiness Index, first find the daily high-low price range for each of the past 14 days.  Next, find the highest and lowest intraday extremes seen over the past 14 days.  Then combine those values using this formula:

Driess was evidently a fan of Fibonacci numbers, because he specified that 38 and 62 are the thresholds for extended readings.  Those are very close to the 0.382 and 0.618 fractions which Fibonistas are very familiar with.  The past 2 years have been interesting in that the 14-day Choppiness Index for the SP500 has seen very few high readings, but a whole lot of low ones.  And not all of those low ones "worked" in terms of marking the end of a trending move. 

That might seem like a flaw, but a wise chartist can turn it into a feature.  A trending move which can persist in spite of a low Choppiness Index reading can be considered a strong trend, which is a nice bit of information to receive.

The recent high Choppiness Index reading came about because for 10 straight trading days the SP500 closed in alternating directions.  That is a rare streak, and pretty much the definition of "choppy" behavior, hence the high score.  The message is that we should expect a trending move to commence.  But again, we are left to turn to other tools to detect which direction that new trending move is traveling.