What is McGinley Dynamic Indicator & How to Use It?

From among the various technical analysis tools and indicators available out there, picking a suitable one can often be a tedious task. Despite several options, most traders tend to stick with commonly used indicators, such as moving averages. However, there are some not-so-well-known indicators too, which can be valuable additions to one’s toolkit. The McGinley Dynamic is one such indicator that can help traders track the market better. In this blog, we will learn what the McGinley Dynamic indicator is and how to use it.

What is the McGinley Dynamic Indicator?

The McGinley Dynamic indicator was created by chartered market technician John McGinley in the 1990s. The indicator, also referred to as Dynamic, is a moving average indicator that takes into account the gap between prices and moving averages. The indicator smooths the data and automatically adapts to the speed of the market.

Why Was the McGinley Dynamic Indicator Created?

To understand the purpose of the McGinley Dynamic Indicator, we need to take a look at moving averages in technical analysis.

Moving averages are one of the most popular technical analysis tools. They help gauge the general direction of the market. However, the market often factors in and prices in any event at a quicker pace than a moving average.

As a result, simple moving averages (SMAs), weighted moving averages (WMAs), exponential moving averages (EMAs), and any other moving averages with a fixed time period are known as lagging indicators.

Since the speed with which a market moves is frequent and inconsistent, most moving averages are not as responsive because they do not consider this factor.

The McGinley Dynamic indicator was created to solve this problem by taking into account the changes in the speed with which the market moves. The indicator has a smoothing factor in its formula, which results in a dynamic moving average that quickly adapts to the market.

Also Read : Best Indicators for Option Trading

Formula and Calculation

Let’s take a look at the formula of the McGinley Dynamic (MDi) indicator.

MDi = MDi-1 + Close – Mdi-1/ k x N x (Close/MDi-1)4

MDi-1 = McGinley Dynamic value of the preceding period

Close = the closing price of the security

N = Number of moving average periods

k = .6 (Constant 60% of the selected period)

With the help of the McGinley Dynamic formula, you obtain a moving average line that smooths out any volatile market movements, helping you track the price quickly and responsively. Depending on the speed at which the price of a security moves, the McGinley Dynamic indicator will accelerate or decelerate accordingly, reducing the lag seen in traditional moving averages.

Advantages over Moving Averages

The McGinley Dynamic indicator has several advantages over traditional moving averages like SMAs and EMAs.

• The key advantage of the McGinley Dynamic Indicator is that it reduces the lag that you see in traditional moving averages.
• It takes the speed at which the market moves to track the price more closely and reduce the gap between the moving average and the price.
• Since the McGinley Dynamic indicator is more responsive, it can help generate more accurate trading signals.
• The indicator speeds up or slows down depending on the volatility in the markets, making it suitable for trending and range-bound markets.
• The indicator can aid traders in analysing the trend in greater detail since it tracks the price more closely and accurately.

When To Avoid The McGinley Dynamic Indicator

Although the McGinley Dynamic indicator tracks the price more responsively than other indicators, there are certain situations in which the indicator may not be an effective tool.

When the market sees a period of low volatility or increased choppiness, the indicator may see whipsaws and generate false signals. Traders should carefully analyse the market and use other tools in conjunction in such situations.

Also Read : Trading the Opening and Closing Market Volatility

Trading Use Cases

Let’s look at how one can use the McGinley Dynamic Indicator to trade an asset.

Since the McGinley Dynamic indicator is a moving average, traders can use the indicator along with studying the price action of a security to enter and exit trades. Here’s a common way to interpret the indicator to make trading decisions.

If the McGinley Dynamic indicator crosses below the price of the asset and is sloping upwards, it can be seen as a bullish signal. Traders can enter into a long position or exit shorts at this signal.

If the McGinley Dynamic indicator crosses above the price of the asset and is sloping downward, it can be interpreted as a bearish signal. Traders can short the asset or exit their long positions at this signal.

As in the case of all other indicators, it is not advisable to rely only on the McGinley indicator. Traders should utilise other indicators, along with the McGinley Dynamic indicator, to get additional confirmation. Some of the common indicators that traders can use include the relative strength index (RSI) and the moving average convergence divergence (MACD).

Traders can also study the price action to spot any patterns or candlesticks which can aid them in effectively entering and exiting trades.