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17th Feb 2021

Everything You Need to Know About the Bitcoin and Gold Correlation

Article Table of Contents:

Simple Moving Averages and Exponential Moving Averages
McGinley Dynamic: Solving the Problem with Moving Averages
The McGinley Dynamic Formula
How to Use the McGinley Dynamic Indicator
MDI Buying Strategy
MDI Selling Strategy

Volatility can be both an advantage and a disadvantage when it comes to trades. Though attractive trading opportunities may arise during times of volatility, the risks are also higher. Nevertheless, there are several indicators that can help traders navigate volatile conditions. Some include Bollinger Bands and the Average True Range (ATR) indicators. Others that may sound familiar are the Keltner channel, which combines both the ATR and exponential moving average (EMA) indicators. However, one indicator that is not often discussed is the MicGinley Indicator, which is of particular advantage during the often volatile cryptocurrency markets. 

The McGinley Dynamic Indicator was developed by John R. McGinley, a market technician and former editor of the Market Technicians Association's Journal of Technical Analysis. Unhappy with the results of moving averages during the 1990s, McGinley began working towards improving the model. 

His aim was to create a responsive indicator with the ability to automatically adjust in response to the market. It resulted in the McGinley Dynamic Indicator, which was published for the first time in the 1997 edition of Journal of Technical Analysis. In order to understand how the McGinley indicator works, we must first look at which indicators its creator aimed to improve. 
When it comes to simple and exponential moving averages, price action is smoothed by dividing the past closing prices with the number of periods. For example, to calculate the simple moving average for 10 days, you must add the closing prices of the past 10 days and divide by 10. The higher the smoothness of the average, the slower it reacts to price changes. 
A 50-day SMA therefore would be slower compared to a 10-day SMA. Volatility can be occasionally high at times, and this makes it difficult to correctly interpret the price action. There can also be false signals during this time as prices get too far ahead. 

Exponential moving average is much quicker to respond to price changes, compared to SMA. This is because it is a weighted indicator. In EMA, greater importance is placed on newer data, making it a great indicator for identifying short-term trends. This is why many traders use simple and exponential moving averages together to determine entry and exit positions. However, EMA can also leave out some data.
McGinley’s research found several problems with moving averages. Firstly, the speed of the market is inconsistent. It slows down or speeds up constantly, and traditional MAs, such as exponential and simple moving averages do not take this into account. The McGinley Dynamic Indicator helps solve this problem by including an automatic smoothening factor into the formula. This helps make adjustments according to the market movements. In trending markets, it speeds up the indicator, while in ranging markets, it slows it down. 

Another greater issue with traditional moving averages is that they use fixed lengths of time. This is problematic because they are unable to keep up with the market, which reacts to events at a very fast pace, and this creates issues called lags. All moving averages, including weighted, exponential, and simple are prone to this problem. Lags affect the reliability of the indicators’ results. The McGinley Indicator, however, takes into account changes in the speed of the market, creating a more responsive and smoother moving average line. 

The dynamic nature of this indicator also helps to ensures that there is no large separation between the moving average line and the price line. This prevents whipsaws and price separation. However, it is important to remember that lags are not completely eliminated. Rather, reactions to the market are faster, making it more reactive than other types of moving averages. 
MDi is the current McGinley Dynamic
MDi-1 is the previous McGinley Dynamic
Close represents the closing price
k is a constant, which represents 60% of the selected period, and
N is the moving average period.

The constant N determines the closeness with which the dynamic tracks the index.
This indicator provides the best results when used with trend following indicators, such as the Relative Strength Index (RSI). In such cases, the RSI is used to provide the confirmation signal. Using the MD indicator in a trading strategy is similar to how other moving averages are used.
When the price moves above the McGinley Dynamic Indicator, it may be a good time to buy. In the example provided below, the RSI line should also be over 50. The stop loss signal can be placed near the swing low. When the price moves around 50 pips over the entry price, it can be a good time to exit the trade.
When the price drops below the MDI, it can be an indication to sell. The RSI line should also be moving below 50 at this point. The stop loss can be placed close to the swing high. You can exit the trade when the price reaches 50 pips lower than the entry price.
It is important to remember that historical data is used by MDI for its calculation. It can give reliable signals as long as the trends develop in the same manner. As such, you must remember that it is an indicator and not a foolproof tool. Having said that, it is considered to be one of the most reliable indicators for the crypto markets, which are known for their high volatility.


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