Kaufmans Efficiency Ratio
This lesson will cover the following
- Explanation and calculation
- How to interpret this indicator
- Trading signals, generated by the indicator
Developed by Perry Kaufman and introduced in his book “New Trading Systems and Methods”, the Efficiency Ratio reflects relative market speed to volatility. There are cases, when it is used as a filter, which helps a trader to avoid ”choppy” markets or trading ranges and to identify smoother trends.
It is the result of dividing the net change in price movement during n-periods by the sum of all bar-to-bar price changes during the same n-periods.
In case the market is trending smoother, then the ratio will be higher. In case the ratio shows readings in proximity to zero, this implies that market movement is inefficient and ”choppy”.
If the Efficiency Ratio shows a reading of +100, this means that the trading instrument is in a bull trend and trending with perfect efficiency.
If the Efficiency Ratio shows a reading of -100, this means that the trading instrument is in a bear trend and trending with perfect efficiency.
It is impossible for any instrument to have a perfect Efficiency ratio, because any movement against the major trend during the examined period of time would cause the ratio to drop.
If the Efficiency Ratio shows a reading above +30, this is indicative of a smoother bull trend. If the ratio shows a reading below -30, this is indicative of a smoother bear trend.
Chart Source: VT Trader