Perry Kaufman – Efficiency Ratio Indicator

Let’s create an indicator of Perry Kaufman from his book, “Trading Systems and Methods.” This comprehensive text provides detailed explanations for each technique with many interesting ideas to explore. We would like start by creating the Efficiency Ratio Indicator today!

Perry Kaufman Trading Systems and Methods - trading strategies

“Trading Systems and Methods” is an excellent book for anybody wishing to enhance their trading system or strategy research abilities. This blog post offers step-by-step instructions on how to build an Efficiency Ratio Indicator (ERI), as well as thorough explanations.

We will code this indicator for tradestation and multicharts following his method to calculate the trend. This indicator shows whether there is actual existence or not of a current trend.

This indicator is a great way to determine when your systematic trading might be losing its edge. When the noise in prices becomes too high, you will start seeing weaker trends and vice versa.

We use this indicator in weekly charts to help us determine when a trend is strong. As you can see, its like an oscillator that increases when the trend has been going on for some time and decreases during weak periods or reverse trends.

What is the Perry Kaufman Efficiency Ratio

The Kaufman Trading Efficiency Ratio is a trading strategy based on Perry Kaufman’s market efficiency model, which he described in his book “Smarter Trading: Improving Performance in Changing Markets.”

The perry kaufman efficiency ratio is obtained by dividing the price variance over time by the total amount of price fluctuations that triggered it. The resulting proportion is between 0 and 1, with higher values indicating a more efficient or trending market.https://www.youtube.com/embed/mC45wc-Pp2A?feature=oembed

The Efficiency Ratio is a measure of efficiency that ranges between 0 and 1. It has the value of 1 when prices move in the same direction for the entire time period during which the indicator is calculated, such as n bars. When prices remain unchanged over the n periods, it has a value of 0.

When the intervals between price changes are short, the denominator of the equation becomes much larger than the numerator, resulting in ER approaching zero.

It’s a unique approach to identify and quantify a financial instrument’s trend. “The trend is your friend” is a well-known trader adage. It implies that trading in the direction of the current flow is a safe, conservative strategy. https://www.youtube.com/embed/gXX9wIcYDl4?feature=oembed

However, in order to keep up with the trend, you must distinguish it from the market’s random noise at any one moment. Kaufman uses his ER to determine whether or not a market is trending.

How to calculate the efficiency ratio

This is a simple formula which can easily be implemented in many trading platforms with various programming languages.

Perry Kaufman Efficiency Ratio Formula

This indicator is easy to construct and may be utilized in numerous trading platforms in a variety of languages. We’ll show you how to generate it in EasyLanguage for TradeStation in this article. We’ve also made some modifications to the indicator to improve its performance.

Perry Kaufman Trend Trading with Efficiency Ratio Indicator Evolved

It’s time to dress up the Perry Kaufman Trend Trading indicator. In fact, we could certainly add direction and display it. The simplest approach to determine a stock’s trend is to use a straightforward procedure: two moving averages of 10 and 40 periods.

When the Fast Moving Average is higher than the Slow Moving Average, the trend is up; when it’s lower, the trend is down. Furthermore, we use 3 and 20 periods moving averages to calculate the Efficiency Ratio’s two MA.

We’re employing Moving Averages since they’re the simplest approach to determine whether a stock is heading up or down.

Many simple trend strategies are built on top of this MA crossover approach. Traders who are new to the market generally start with this method. We don’t just combine the price in this situation; we also average the indicator’s value.

Perry Kaufman Trend Trading with Efficiency Ratio Indicator Basic

When the shorter Moving Average on the Close Price (10 periods) surpasses and maintains above the slower MA (40 periods), the trend is UP; when it crosses and falls below, it’s DOWN. 

If the Kaufman Indicator’s faster Moving Average (3 periods) crosses and stays above the slower MA (20 periods), the indicator color changes to green.

When the Kaufman Indicator’s faster Moving Average (3 periods) crosses and stays beneath the slower MA (20 periods), suggesting a fall in the trend, it turns red.

This indicator has shown great performance; for example, it performed well during the 2007-2008 financial panic.

Perry Kaufman Efficiency Ratio Indicator during the financial crisis Kama

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Conclusion

You must consider the trend every time you make a trading decision. Keep in mind that trends only exist at higher time scales. As a result, this signal will be utilized only on daily and weekly charts. The high value for the Slow Moving Average (min 40) is critical.

In the shorter time frame, the noise is too loud, and you can’t discover a solid trend to trade. When the noise is high, only mean-reverting strategies should be used. It may be used as a trend filter for futures, equities, and forex markets.

In most cases, we use it to halt trading activity or modify the strategy. Keep in mind that you must first ask yourself if a trend-follower technique is acceptable under certain circumstances.

If we employ a mean-reverting approach, we want the indicator to be close to 0. On the other hand, if the indicator is near 1, we should only use trend followers.

Kama Kaufman Moving Average Link

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WIKIPEDIA: Perry Kaufman

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