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Indicator: ER indicator with Forumla, Strategy, Advantages and Limitations - Trading Worker
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ER (Efficiency Ratio)

The Efficiency Ratio (ER) is a technical indicator that measures the efficiency of price movement by comparing the net directional movement to the total price volatility over a specified period. It helps traders identify trending and ranging markets, as well as potential trend reversals.

Formula

ER = |Close - Close(n periods ago)| / Σ|Close(i) - Close(i-1)|
Where:
n = number of periods
Σ = sum from i=1 to n
|x| = absolute value of x

How ER Works

The Efficiency Ratio ranges from 0 to 1, where values closer to 1 indicate efficient price movement (trending market) and values closer to 0 indicate inefficient movement (ranging market). The indicator helps traders determine whether to use trend-following or range-trading strategies based on current market conditions.

Trading Strategies Using ER

Strategy Examples

  • Use trend-following strategies when ER > 0.6
  • Apply range-trading strategies when ER < 0.4
  • Look for trend exhaustion when ER starts declining from high levels
  • Combine with momentum indicators for confirmation
  • Use multiple timeframe analysis for better accuracy

Support and Resistance Strategy

  • Monitor ER values at key support/resistance levels
  • Look for high ER values during breakouts
  • Use low ER values to identify potential reversal zones
  • Combine with volume analysis for level validation
  • Watch for divergences at major price levels

Trend Identification

  • High ER values confirm strong trends
  • Declining ER suggests trend weakness
  • Use ER threshold levels for trend classification
  • Monitor ER slope for trend momentum
  • Look for ER divergences for trend reversal signals

Advantages and Limitations

Advantages

  • Clear distinction between trending and ranging markets
  • Helps select appropriate trading strategies
  • Can identify potential trend reversals
  • Works well with other technical indicators

Limitations

  • May produce lag in rapidly changing markets
  • Requires confirmation from other indicators
  • Can give false signals in choppy markets
  • Sensitivity to period selection

Best Practices When Using Efficiency Ratio (ER)

  • Use multiple timeframes to confirm ER signals
  • Combine ER with other technical indicators for validation
  • Wait for clear ER threshold crossovers before taking positions
  • Monitor ER divergences with price for potential reversals
  • Consider market conditions when interpreting ER readings
  • Use ER to validate support and resistance levels
  • Backtest different ER period settings on historical data
  • Document and track which ER patterns work best for your trading
  • Adjust ER thresholds based on market volatility
  • Regularly review and optimize your ER trading strategy