The McGinley Dynamic indicator (MDI) is an effective tool for traders who want to improve their grasp of market trends and avoid false signals.
While traditional moving averages are inherently lagging indicators, especially during periods of extreme volatility, the McGinley indicator is designed to dynamically adjust to market speed. When asset prices fluctuate rapidly, the indicator responds quickly. When the market is dull, the McGinley indicator also exhibits a more moderate reaction.
The indicator helps you more accurately determine the market’s direction and make more informed trading decisions. This article explains how the McGinley indicator works, what its formula is, and how to apply it in live trading conditions.
The article covers the following subjects:
Major Takeaways
- The McGinley Dynamic indicator is a technical analysis tool that gives you better insight into price movements. The MDI shows price changes more precisely and smoothly than simple moving averages (SMA) or exponential moving averages (EMA).
- The indicator’s formula includes the current price, the previous value, and a period. The latter changes depending on how quickly the price fluctuates.
- To set up the McGinley indicator, select a smoothing constant period. If it is low, the indicator will respond quickly to price changes. If the period is high, the moving average will be smoother.
- If the price rises above the MDI line, then the quotes are likely to increase. If the price falls below the line, then a decrease in quotes is possible.
- The MDI can be used in different ways. For example, you can follow the trend and open trades in its direction, or you can use the MDI to confirm signals given by other indicators.
What Is the McGinley Dynamic Indicator?
The McGinley Dynamic indicator was developed to provide a faster response to market changes than a standard moving average. It was created by John McGinley, a certified market technician (CMT) and former editor of the Market Technicians Association’s Journal of Technical Analysis. He developed this responsive indicator to address a problem inherent in lagging moving averages.
A standard moving average line uses data over a specific period, like 20 days. The McGinley indicator adjusts the period based on how fast the price changes. This means it reacts faster to new trends and helps traders spot market shifts in time.
McGinley Dynamic Formula and Calculation
The McGinley Dynamic indicator’s formula uses the current price, the previous indicator value, and a smoothing factor.
The smoothing parameter varies with the speed of price changes, allowing the indicator to respond swiftly to price fluctuations during periods of high volatility and to slow down when the market is consolidating.
The McGinley dynamic formula:
where:
- MD (i) — value for the current period;
- MD (i-1) — value of the preceding period;
- Close — closing price;
- N — number of periods (MA).
Setting Up McGinley Dynamic Indicator
It is relatively easy to tune the McGinley Dynamic indicator. First, you need to set the period. It determines the indicator’s sensitivity to price fluctuations.
If the period is short, the indicator will react even to the slightest shifts in quotes. On the one hand, it sounds great, but it can generate a lot of false signals.
With a long period, on the contrary, there will be fewer false signals, but the response to market changes will be delayed. The moving average indicator will lag, and the price may travel a long distance in either a bullish or a bearish trend.
Try setting different periods to see how the indicator works in different conditions. The key is to adjust the period to the market and determine the one that best aligns with your strategies and investment objectives.
Add the McGinley Dynamic indicator to the chart. You can also use the following indicator settings:
1. In the Inputs tab, set the Length parameter. The default value is 14, but you can reduce it to 10 for more convenient intraday trading.
2. Set the Timeframe parameter and select the chart.
3. Make sure to check the Wait for timeframe closes setting.
4. In the Style tab, set the Precision parameter to 8.
5. Check the boxes for Labels on price scale and Values in status line.
How to Read McGinley Dynamic Trading Signals
Trading signals are generated based on the position of the asset price relative to the indicator line on the chart. For example, if the price crosses the McGinley line from below, this often signals the beginning of an uptrend. Conversely, if the price crosses below the MDI line, a bearish trend is likely to begin.
It is essential to confirm signals with other reliable indicators, such as MACD, the RSI, MFI, OBV, and others. You can also use candlestick patterns to validate the signal and reduce market noise.
Identifying Bullish Signals
If the price settles above the McGinley dynamic line, then the market is trending upward. If you see this setup, you can open long positions.
In the screenshot above, you can see the MACD line crossing the signal line from below. This confirms the McGinley indicator’s signal to open a buy trade.
Notably, Hammer, Morning Star, and Bullish Engulfing candlestick patterns signal growing buying pressure, suggesting the trend is likely to reverse to the upside.
Identifying Bearish Signals
When an asset’s price trades below the McGinley dynamic indicator line, the market is highly likely bearish. To ensure the signals are accurate, check additional technical indicators.
In the screenshot above, the MACD line has crossed the signal line from above, with the histogram starting to decline in the negative zone. This is a signal to open a short position.
You may also see the Evening Star candlestick pattern, as well as the Shooting Star, Hanging Man, and Three Black Crows patterns. These patterns show that the uptrend is about to reverse.
McGinley Dynamic Trading Strategies
There are several ways to trade using the McGinley indicator. One of the most effective methods is to open and close trades when the price intersects the MDI line, using technical indicators and candlestick patterns for confirmation.
Below is an example of trading the XAU/USD on the hourly chart.
The trading system is as follows:
- Support and resistance levels were determined.
- The McGinley and MACD indicators were plotted on the chart.
- A Morning Star candlestick pattern gave the first reversal signal near the key support level of $4,192.15.
- The price broke through the McGinley dynamic line from below. Gold continued to grow on increased trading volume.
- Gold quotes rebounded from the $4,238.75 resistance level and tested $4,217.57. At this mark, the price crossed the MDI line several times, fluctuating within a narrow range.
- Several Bullish Engulfing patterns emerged near $4,217.57, pointing to a looming uptrend.
- After the second Engulfing pattern, a long position was opened with a Stop-Loss order placed around $4,200.87.
- Profit-taking levels: $4,238.75, $4,265.91, and $4,284.36. After reaching $4,284.36, the price corrected. The McGinley line was still below the market price, but the MACD indicator crossed the zero line from above, giving a signal to close the long position.
Conclusion
The McGinley Dynamic Indicator is a reliable tool for traders who prefer to stay on top of volatile markets and find the best entry points. It automatically changes its speed based on price fluctuations, so it outperforms regular moving averages. All you need to do is set the indicator parameters that suit your trading style and market conditions.
However, McGinley’s indicator is not flawless and can generate false signals. Therefore, it is better to use it in conjunction with other indicators and candlestick patterns. You can hone your trading skills online on a free demo account with LiteFinance: learn how to use technical indicators and develop your own strategies.
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McGinley Dynamic Indicator FAQs
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