The McGinley Dynamic is a little-known yet highly reliable indicator invented by John R. McGinley, a Certified Market Technician and former editor of the Market Technicians Association's Journal of Technical Analysis. Working within the context of moving averages throughout the 1990s, McGinley sought to invent a responsive indicator that would automatically adjust itself in relation to the speed of the market. His eponymous Dynamic, first published in the Journal of Technical Analysis in 1997, is a 10-day simple and exponential moving average with a filter that smooths the data to avoid whipsaws.
Simple Moving Averages vs. Exponential Moving Averages
Simple moving averages (SMAs) smooth out price action by calculating past closing prices and dividing by the number of periods. To calculate a 10-day simple moving average, add the closing prices of the last 10 days and divide by 10. The smoother the moving average, the slower it reacts to prices. A 50-day moving average moves slower than a 10-day moving average. A 10- and 20-day moving average can at times experience volatility of prices that can make it harder to interpret price action. False signals may occur during these periods, creating losses because prices may get too far ahead of the market.
An exponential moving average (EMA) responds to prices much more quickly than a simple moving average. This is because the EMA gives more weight to the latest data rather than the older data. It's a good indicator for the short term and a great method to catch short term trends, which is why traders use both simple and exponential moving averages simultaneously for entry and exits. Nevertheless, it too can leave the data behind.
The Problem with Moving Averages
In his research, McGinley found moving averages had many problems. In the first place, they were inappropriately applied. Moving averages in different periods operate with varying degrees in different markets. For example, how can one know when to use a 10-day to a 20- to a 50-day moving average in a fast or slow market? In order to solve the problem of choosing the right length of the moving average, the McGinley Dynamic was built to automatically adjust to the current speed of the market.
McGinley believes moving averages should only be used as a smoothing mechanism rather than a trading system or signal generator. It is a monitor of trends. But a 10-day simple moving average is off by five days or half its length. Chances are good that the big move in prices already occurred by the fifth day of a 10-day simple moving average. In addition, a 10-day moving average should properly be plotted five days before the present datum.
Further, McGinley found moving averages failed to follow prices since large separations frequently exist between prices and moving average lines. He sought to eliminate these problems by inventing an indicator that would hug prices more closely, avoid price separation and whipsaws and follow prices automatically in fast or slow markets.
McGinley Dynamic Formula
This he did with the invention of the McGinley Dynamic. The formula is:
MDi is the current McGinley Dynamic
MDi-1 is the previous McGinley Dynamic
k is a constant equaled to 0.6 (60% of a selected moving average period N)
N is the moving average period
close is the closing price
The McGinley Dynamic looks like a moving average line, yet it is actually a smoothing mechanism for prices that turns out to track far better than any moving average. It minimizes price separation, price whipsaws, and hugs prices much more closely. And it does this automatically as a factor of its formula.
Because of the calculation, the Dynamic Line speeds up in down markets as it follows prices yet moves more slowly in up markets. One wants to be quick to sell in a down market, yet ride an up market as long as possible. The constant N determines how closely the Dynamic tracks the index or stock. If one is emulating a 20-day moving average, for instance, use an N value half that of the moving average or in this case 10.
It greatly avoids whipsaws because the Dynamic Line automatically follows and stays aligned to prices in any market fast or slow—like a steering mechanism of a car that can adjust to the changing conditions of the road. Traders can rely upon it to make decisions and time entrances and exits,
The Bottom Line
McGinley invented the Dynamic actually to act as a market tool rather than as a trading indicator. But whatever it's used for, whether it is called a tool or indicator, the McGinley Dynamic is quite a fascinating instrument invented by a market technician that has followed and studied markets and indicators for nearly 40 years. In creating the Dynamic, McGinley sought to create a technical aide that would be more responsive to the raw data than simple or exponential moving averages.
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