The Efficiency Ratio indicator, also known as Fractal Efficiency, was created by Perry Kaufman and described in his book Smarter Trading. The main purpose of this indicator is to measure the trend efficiency in order to distinguish the trend from the random noise in the price movement.
The Efficiency Ratio (ER) is calculated by dividing the price change over specified period by the sum of the absolute differences between closing prices for that period. The result can be also interpreted as a ratio of the price direction to its volatility. The higher the efficiency ratio, the faster the trend.
- Values around 1 indicate a very strong trend – this happens when the market has been moving in the same direction throughout the whole observed period.
- Values around 0 indicate noisy market without clear direction
Please note that the indicator does not show the direction, but the efficiency of the price movement.