Investing & Trading

Efficiency Ratio Study

By Samantha Baltodano


TL;DR:

The Efficiency Ratio (ER) Indicator is a technical indicator used to measure the strength of a trend in the market. It's used to identify potential buy and sell signals by traders. 


The Efficiency Ratio is calculated by dividing the change in price over a period by the total sum of changes in price over the same period. 


The period used in the calculation can vary, but it's usually calculated over a period of 10 or 14 days. Traders often combine the ER with a moving average to generate trading signals based on a fixed trend level of 0.7.


What Is The Efficiency Ratio Study?

The Efficiency Ratio (ER) Indicator is a popular technical indicator that’s used to measure the strength of a trend in the market. Traders use this to determine the strength of an underlying security’s trend and to identify potential buy and sell signals. 


It is a ratio of the change in price over a period to the total sum of changes in price recorded on a bar-by-bar basis over the same period (more to come later). The Efficiency Ratio produces values ranging from 0.0 to 1.0, with higher values indicating stronger trending conditions.


In essence, the ER is a measure of how “efficiently” a security’s price is moving in a trend. The more efficiently the price is moving in a trend, the higher the Efficiency Ratio. 


When the Efficiency Ratio is high, it’s an indicator that the trend is strong and that it will probably continue. Conversely, when the Efficiency Ratio is low, it suggests that the trend is weak, and it could reverse.


Calculation

The Efficiency Ratio is calculated as follows:


  • ER = Change in price over a period / Total sum of changes in price over the same period


The period used in the calculation of the Efficiency Ratio can vary depending on the trader's preference. However, it is usually calculated over a period of 10 or 14 days.


Traders often combine the ER with a moving average. They use a fixed trend level of 0.7, which acts as a threshold for identifying potential trends in the market. 


When the Efficiency Ratio is combined with a moving average, traders can use it to generate trading signals. For example, a buy signal may be generated when the Efficiency Ratio crosses above the trend level while the price is above the moving average. 


Conversely, a sell signal may be generated when the Efficiency Ratio crosses below the trend level while the price is below the moving average.


Test The Efficiency Ratio Study

Great news! 


You can back test this exact strategy on historical data for any of your favorite symbols using TradingView. 


This strategy has already been built and all you have to do is log in and take it for a spin. You can access this indicator here.


If you’re new to back testing and to TradingView, don’t worry. I created a step-by-step guide you can follow to begin testing the Efficiency Ratio Study.


Summary

  • The Efficiency Ratio Indicator is a technical tool used to measure the strength of a trend in the market, and to identify potential buy and sell signals.
  • The Efficiency Ratio is a ratio of the change in price over a period to the total sum of changes in price recorded on a bar-by-bar basis over the same period, and produces values ranging from 0.0 to 1.0.
  • The Efficiency Ratio measures how efficiently a security's price is moving in a trend, with higher values indicating stronger trending conditions.
  • Traders often combine the Efficiency Ratio with a moving average and use a fixed trend level of 0.7 as a threshold for identifying potential trends in the market.
  • When the Efficiency Ratio is combined with a moving average, traders can use it to generate trading signals, such as a buy signal when the Efficiency Ratio crosses above the trend level while the price is above the moving average, and a sell signal when the Efficiency Ratio crosses below the trend level while the price is below the moving average.


Efficiency Ratio is just one of many studies that Archaide automates. For a full list of strategies and studies available click here.


Like what you read? Check out the rest of our content!