McGinley Dynamic Indicator
Categories: Financial Theory
Before getting into the complications inherent in describing the McGinley Dynamic Indicator, we're going to take a brief detour into sixth-grade math. Specifically, we're going to talk about averages.
We're not actually going to describe how to figure out an average (we'll assume you've got that one in your bag of tricks already). But it's beneficial for our purposes here just to remind you what an average is, and have you conjure the idea in your head.
Got it? Okay, now we're going to inject that concept with some industrial-grade horse steroids. First step on the way to Mr. McGinley and his dynamic indicator: a moving average.
A moving average involves taking the average of a set number of items, and then shifting the actual items involved as you move forward in time. The idea is to flatten out fluctuations in a constantly updating data set and get a clear trend line. It's a pretty common concept in technical analysis of the stock market. A 50-day moving average adds up each of the last 50 trading days worth of closing prices for a stock, and then divides that sum by 50. In other words, it takes the average.
That provides one data point. Then, the next day, you do it again, only move everything up a day. You're still taking the last 50 trading sessions, but since you've moved forward in time, the whole data set has moved forward a day as well. Keep this up for every day in the time set you are looking at...then connect all the data dots to draw a line. That line represents your 50-day moving average.
Okay, so a moving average exists as a jacked-up version of an average. The McGinley Dynamic Indicator acts as a jacked-up version of a moving average.
It works on a similar concept, but adds a refining complication. It's not a simple average. The McGinley Dynamic Indicator takes into account changes in market speed. Specifically, the McGinley Dynamic Indicator assumes that investors are more likely to pull the trigger on panic selling then they are on what might be described as "panic buying." To put it another way, they are more scared of losing money than they are of missing out on profits.
Therefore, the market tends to drop more quickly than it rebounds. These deeper-than-rational dips muddle the moving averages (downward blips tend to move further off the trend line than upward ones), making the averages lower than they should be (at least in the opinion of creator John McGinley).
The formula for the McGinley Dynamic Indicator (which is too complicated to go into here) adjusts for the market speed in the trend line it presents.
Related or Semi-related Video
Finance: What are moving averages?7 Views
Finance a la shmoop... what are moving averages? ooh I need another tissue that [Girl crying]
average I just can't get enough so moving okay yeah yeah that's not at all
what this term is about here's a chart here's a set of trailing averages 50-day
the blue line they're hundred-day the black line and 200-day the green line
there... note that we say trailing average why trailing? well people we lost our
crystal ball yeah Warren we know you took it [Warren Buffett eating dinner]
so averages for normal humans can only be trailing because trailing stockticker
closing prices give us data we can actually use stock averages don't take
future data that we're merely guessing at on their charts... only
real numbers that we can actually point to so here's the 50-day average for [50-day average for coca cola stock]
coca-cola stock KO in 2012 and if we move forward a year and change well here
it's a 50-day average right there looks a little bit different and while the 50
data input elements from its closing price each day vary so the average of
those data points will move and why do moving averages matter well for
fundamental analysts kinds of investors you know the people who care just about [Fundamental analyst people appear]
the cash flow and earnings and margins and revenue growth of companies well
really don't matter but for chartist types of investors that is those who
focus really only about trading trends and shapes and curves and the metrics
behind what patterns of stocks take in the future well, they matter a lot then
in fact the 200-day moving average is generally a kind of Chartist living [Priests in church]
Bible for most Wall Street traders and taking meaning from it is all about
recognizing patterns and then imputing likely future patterns based off of
those shapes for example if you're looking here at the peak of a Head and [Head and shoulders stock price graph]
Shoulders chart, the trailing average of this
say 50-day set here of data points is the line about here but if you move
forward and look at the back half well then the moving average is about here [Moving average lines moves]
and if you consider the entire chart well it's about here and the lines are
there in theory to give color as to what direction the
market or this given stock is heading and yep sometimes it works and sometimes
it doesn't [Man eating dinner with Warren Buffett]