Using the Choppiness Index to See How Stocks Move After Spikes

A reading of 62 or greater is often used as a sign of a very choppy market

Senior Quantitative Analyst
May 10, 2023 at 8:00 AM
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Does it feel like stocks have been going nowhere for a long time now? It seemed that way to me, so I looked at an indicator which I rarely think about. It’s the Choppiness Index, which was developed by a commodity trader named E.W. Dreiss.

The indicator measures the trend of a time series. High values mean very little trend (a choppy market) and low values indicate a strong trend. My intuition was correct. I calculated the Choppiness Index for the S&P 500 Index (SPX). The chart below shows the index spiked and recently hit the 62 level that is often used as a benchmark for a choppy market. This week I’m looking at how stocks have behaved based on the obscure Choppiness Index.

Choppiness Index

Index Spikes

I mentioned above a Choppiness Index reading of 62 or greater is often used as a sign of a very choppy market. Using the indicator on the SPX, I found times that the Choppiness Index reached this level for the first time in at least three months. I went back to 1980. That’s when we start getting consistent high/low data on the SPX which is needed for the calculation of the indicator.

The index hit 62 a couple weeks ago on April 25. The first table below shows how the SPX has performed after these signals. The second table, for comparison, shows typical SPX returns. The returns after these signals look a lot like the returns you can expect at any time, and one month after a signal the SPX averaged a gain of 0.77%, with 60% of the returns positive. Typically, stocks averaged a 0.81% gain with 63% of returns positive. So, based on this, the index tells us we’ve been chopping around but it isn’t much help at telling us where we go from here.

Choppiness Index 62

I looked at this one more way. Again, I went back to 1980 on the SPX. I grouped the dates together based on the Choppiness Index reading, then found the return over the next month of the stock market. The recent Choppiness index reading was around 59 putting us in that very last row of high readings. The SPX underperformed over the next month at these high readings. Stocks averaged a gain of 0.62% after similar readings, which is the lowest average return in the table. However, the table shows the best results were when the Choppiness Index was between 40 and 45 or between 50 and 55. Then the returns weren’t that good when the readings were between 45 and 50. This makes me skeptical of using this as a stock market indicator going forward. It’s only useful for telling us the recent stock market environment.

SPX 1-Month Choppiness Return

 

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