This lesson will cover the following
- Explanation and calculation
- How to interpret this indicator
- Trading signals, generated by the indicator
Developed by John McGinley in 1990 and introduced in the Market Technicians Association’s Journal Of Technical Analysis in 1997, the McGinley Dynamic indicator attempts to solve the lag problem, which traditional simple and exponential moving averages encounter. It adjusts itself automatically in relation to the speed of the market. This indicator is considered to be a smoothing mechanism for prices, which follows them much more closely than any moving average. This way price separation and whipsaws are reduced to a minimum. The McGinley Dynamic (MD) indicator can be calculated as follows:
MD = MD1 + (Price – MD1) / (N * (Price / MD1) ^ 4), where
– MD1 refers to the prior value of the Dynamic indicator
– N refers to a Dynamic Tracking factor
As a result of this calculation, the Dynamic Line increases its speed during bear trends, as it follows prices, while it moves more slowly during bull trends. In the formula above the difference between the Dynamic and the price is divided by N times the ratio of the two to the 4th power. This 4th power adds an adjustment factor to the calculation, which rises more suddenly, as the difference between the Dynamic and the current data becomes larger.
McGinley suggests that traditional moving averages and his Dynamic indicator should be used as smoothing mechanisms rather than as trading systems or signal providers. However, it is possible for a trader to use the McGinley Dynamic the same way moving averages are generally used. On the chart below the difference between the Dynamic and the 20-period Exponential Moving Average can be seen.