The Kaufman Efficiency Ratio, was developed by Perry Kaufman and determines whether a market is trending or range bound. It is therefore an alternative to for example the Directional Movement and the ADX indicators. Other than the below description, you may want to review our Efficiency Ratio Indicator Spotlight (with video).
Indicator Description
The Kaufman Efficiency Ratio indicator, a.k.a. Fractal Efficiency is calculated by dividing the price difference between the current bar and the absolute price movement of the N-bars in the lookback period:
ER = 100 * (Close[0] – Close[N]) / SUM (Abs(Close[i] – Close[i-1])
In a perfect trend, where all bars close in the same direction and do not overlap, the Kaufman Efficiency Ratio will show a value of 100. A perfect sideways market without momentum in either direction, will show a value of 0. Accordingly, this indicator compares momentum with volatility.
Efficiency Ratio Features:
- Other than the Standard Momentum calculation, one may also choose Balanced Momentum to eliminate the dropout effect. This refers to a significant jump in momentum when the last bar in the lookback period “drops out”. The dropout effect will occur although there’s no significant change in the most recent price action. You may eliminate the dropout effect with the Balanced Momentum calculation, which is the default option for our Efficiency Ratio indicator. The tail end of the N-bar lookback period is calculated with a triangular Moving Average.
- A low Kaufman Efficiency Ratio value indicates a sideways market, whereas higher values a trending market. However, the Efficiency Ratio indicator values will change depending on the chosen lookback period. For example, when using a lookback period of 10 bars, the Efficiency Ratio indicator may show a value of 100. However, when using a lookback period of 100, we will almost certainly never see a perfect Kaufman Efficiency Ratio of 100. Accordingly, the chop line threshold should be lower for longer lookback periods and this indicator does so automatically.
- The indicator furthermore has paintbars. Bars above the chopline plot in green or red, bars that plot below are yellow.
Other Library Indicators
The Kaufman Efficiency Ratio indicator is frequently used to distinguish between trending and sideways markets. You may therefore use it in combination with other tools for technical analysis, such as channel indicators, support / resistance levels and volume analysis. For channel indicators, check out the Squeeze Momentum Channel which was reviewed in in this Spotlight episode.
For support / resistance levels, you may have a look Fibonacci retracements (Fibs), such as the Prior Day Fibs / Current Day Fibs, Prior Week Fibs / Current Week Fibs, the Current Month Fibs / Prior Month Fibs or the Current N Month Fibs / Prior N Month Fibs. An Indicator Spotlight previously looked at the Fibonacci Retracement lines.
For volume analysis you may review Better Volume
The Kaufman Efficiency Ratio indicator is available for NinjaTrader 8
