What is the McGinley Dynamic indicator?
Sometimes referred to as “the best moving average you‘ve probably never heard of,” the McGinley Dynamic indicator is a popular technical analysis tool designed to improve traditional moving average indicators. It shows the average price of a stock or other asset over time adjusted for shifts in market pace.
Traditional moving averages – whether exponential, simple or weighted moving averages – use fixed time spans and don’t account for changes in market speed. As market pace can change many times during a single trading session, the lag can distort information.
The McGinley Dynamic indicator aims to solve this problem by accelerating when the market speeds up and slowing when the market decelerates.
Who invented the McGinley Dynamic indicator?
The McGinley Dynamic indicator is named after market technician John R. McGinley, a former editor of the Market Technicians Association’s Journal of Technical Analysis.
Having studied technical analysis strategies and trading techniques for close to 40 years, McGinley observed that traditional moving average indicators can often separate from a price in volatile markets.
In the 1990s, McGinley developed the indicator into a responsive tool that would provide a more accurate picture of price movement than a traditional moving average. The McGinley Dynamic indicator was first introduced in the Journal of Technical Analysis in 1997.
Why is the McGinley Dynamic indicator useful for traders?
The McGinley Dynamic is a useful technical analysis tool for traders. It’s more responsive than other moving averages and minimises whipsaws. It allows traders to adjust their trading decisions in response to changing market conditions. A McGinley Dynamic trading strategy avoids the false price signals that can occur with other moving averages during times of heightened price volatility.
It can be difficult to know whether to look at a 10-day, 20-day or 50-day moving average for the most accurate reflection of a price trend. The McGinley Dynamic indicator answers this question by automatically adjusting to the market pace. This saves traders time in having to look at several price charts for different intervals, minimising the chance of them missing changes in price trends and trading opportunities.
How to interpret the McGinley Dynamic indicator
The McGinley Dynamic indicator formula and calculation incorporate automatic smoothing. The indicator line is calculated without averaging any values, reducing the lag. The calculation subtracts the previous value from the price and with dynamic tracking smooths the price trend.
Traders can customise the formula to study different time periods. This helps form a clearer picture of a market’s direction and lessens the impact of short-term volatility.
The smaller the number of periods in the formula, the less market noise the calculation filters out. The indicator smooths out price data over time. Because a shorter time period reacts to price changes more quickly, traders typically use periods of 7, 14, 26 and 52 days.
When the indicator line on a price chart moves up, a security’s price is on an upward trend. When the line moves lower, the price is trending down.
Because the McGinley Dynamic gets closer to prices than other moving averages, if the chart’s price line or candlestick deviates sharply from the indicator line, it reveals a possible trend reversal.
How to trade using the McGinley Dynamic indicator
Traders can use the McGinley Dynamic to monitor trends on a price chart and better decide when to buy and sell. They can use the indicator, along with support and resistance levels, to decide whether to take a long or short position on a security, such as a stock, commodity or forex pair.
If the McGinley Dynamic indicator is in an area of price support, a trader could wait until the price bounces off and the candlestick moves above the indicator line to buy, placing a stop-loss order below the indicator line. If the candlestick pattern changes from a bullish candle to a bearish candle, the trader should exit the position.
Conversely, if the McGinley Dynamic indicator is in a resistance area, a trader can choose to sell a security when the price bounces off resistance and the candle moves below the indicator line. A stop loss would be placed above the line.
Traders can combine the McGinley Dynamic indicator with volatility and volume indicators to confirm price trends. Pairing it with an oscillator indicator, such as the relative strength index (RSI), can give a stronger indication of a trend’s direction.
An RSI higher than 50 indicates the price of a security is on an uptrend. If the price then moves above the McGinley Dynamic indicator, the security is a buy. If the RSI is below 50 and the price falls below the McGinley indicator, the security is a sell.
Limitations of using the McGinley Dynamic indicator
The McGinley Dynamic indicator was designed as a smoothing mechanism. It should not be the only technical indicator a trader refers to when making investment decisions. While it reduces the issue of lag, it does not remove it completely.
Traders need to be cautious. The indicator line moves faster when markets fall than when they rise. Knowing this allows traders to sell quickly when a security enters a downward trend and hold a position for as long as possible in a rising market. The indicator is more difficult to use when the price action on a security is sideways, as there is no clear trend.
A McGinley Dynamic indicator strategy should also incorporate other types of technical analysis tools, such as the RSI and moving average convergence divergence (MACD), to confirm the trend the indicator is showing on the price chart.
