McGinley Dynamic Indicator
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.