The McGinley Dynamic is a little-known yet highly reliable indicator invented by John McGinley somewhere in the late '80s or early '90s. Almost nothing has been published regarding the McGinley Dynamic since its inception. We may not learn the calculations of his indicator but we can learn the value of his indicator by its characteristics. I base my assumptions of the McGinley Dynamic first on a one-page journal article published almost 20 years ago and because I have used this indicator and find great value in its use.
What Is it? The McGinley Dynamic can be easily described as a 10-day simple and exponential moving average with a smoother: a filter that smooths the data to avoid whipsaws. Yet its reliability as an indicator is much greater than that a moving average since moving averages tend to forecast false signals, especially during periods of whipsaw price action such as an out of sync economic release or periods of stops and starts of trends. The McGinley Dynamic may look and act like a moving average but it is the filter that gives this indicator its profound reliability.
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To further understand the McGinley Dynamic, a quick lesson in moving averages may help. Simple moving averages smooth out price action by calculating past closing prices and dividing by the number of periods. To calculate a 10-day moving average, add the closing prices of the last 10 days and divide by 10. The hope is to forecast future prices based on past price action. 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 a volatility of prices that cannot always gauge future price action. False signals may occur during these periods, creating losses for traders because prices may get too far ahead of the market. (For more, read Do Adaptive Moving Averages Lead To Better Results?)
Exponential Moving Averages An exponential moving average responds to prices much more quickly than a simple moving average but may cause false breaks due to volatility or price spikes. It's a good indicator for the short term and a great way to catch short-term trends which is why traders use both simple and exponential moving averages simultaneously for entry and exits. Yet as stand-alone indicators, traders could get caught with losses if they're not careful. Hence the reason the McGinley Dynamic was anchored as a moving average.
Why McGinley Is Different What separates the McGinley Dynamic from its moving average counterparts is that it tracks like a moving average in trending markets yet it is more of a constant indicator and holds its consistency both in the long- and short-term due to the mysterious filter. The drawback is simple. The McGinley Dynamic lags prices and candles. This can scare traders and force them to make erroneous decisions regarding future price movements. However, as long as the McGinley Dynamic line is pointing up or down, traders can feel confident regarding direction. Don't be fooled by the color of a candle along the trend.
Certain volatility periods will exist with this indicator because it's an indicator that forecasts trends, not short-term volatilities. As a trend indicator for the long term, it's a good and reliable signal. The longer the time frames used, the better the forecast of a trend. For time frames shorter than 60 minutes, this indicator works but like any indicator in shorter time spans, it's buyer beware. (Learn more in The Art Of Candlestick Charting.)
If markets gain momentum, simple and exponential moving averages can lag while the McGinley Dynamic moves with prices. This is why the term "dynamic" is used; it's dynamic because the line moves with prices up or down unless prices experience drastic spikes. In this instance, look at the dynamic line as a mean in a standard deviation equation. Prices will always revert back to the mean. So extreme price spikes should always be sold in uptrends and bought in downtrends until they again approach the dynamic line. The dynamic line always speeds up or slows down with prices; it's a constant line that moves but not as fast as moving average lines.
In instances of extreme volatility, the McGinley Dynamic can't react fast enough to market changes. The best decision is to use a volatility indicator such as Bollinger bands or a stochastic oscillator with the McGinley Dynamic. This method will serve traders well.
What You Need To Know Because the Dynamic Line is a forecaster of trends, periods of range-bound markets can be complicated. In this example, shorter time frame charts may be the answer to determining future direction. This would serve scalpers well and discourage swing traders. For periods of market uncertainty, the McGinley Dynamic tracks almost the same as Parabolic SAR, stop and reverse, and the Tenkan line in the Ichimoku indicator. No indicator should ever be deployed alone because we can never be absolutely positive regarding market tendencies. Confirmation of trend direction is always useful.
Entry and exits are tricky as a stand-alone indicator. In uptrends, exit when the Dynamic Line flattens or when prices breach the line. Always be careful of false breaks especially in fast markets as this can be a tendency of this indicator even on longer-term charts. Be mindful that prices revert back to the mean. Enter an uptrend when the Dynamic Line turns up. Enter downtrends when prices breach the line downward and exit when prices either breach the line upside or the line flattens.
The Dynamic Line is set as a standard 14 periods but these periods can be adjusted. For faster response to prices, set the periods lower but beware of true false breaks and whipsaws. This indicator will then act more like an oscillator than a moving average. For slower response periods, set the number higher. This will give a true reading of the market but may take longer to achieve price objectives. However, the 14 periods correctly forecasts trends so you may want to just leave it as is.
The Bottom Line The best way to learn about the McGinley Dynamic is to watch and analyze prices as the indicator moves. Use various time-framed charts and more importantly, learn entry and exit points. It's an 18 year old indicator that lives up to its reputation for its reliability. (To learn more, see Technical Analysis: Indicators And Oscillators.)