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As known, the disadvantage of standard moving averages is lagging. In the moving average of the Kaufman AMA, this drawback is eliminated due to the dynamically changing calculation period, depending on the market situation.
The AMA trend trading indicator is displayed as a line with dots that change their color depending on the calculations of the two moving averages specified in the indicator parameters.
The Kaufman moving average retains the ability to recognize trends in time without delay, while the market noise does not distort its markup as much as it does with regular MAs. For this effect, the Kaufman MA was created.
Indicator calculations
To determine the current state of the market, Kaufman introduced the concept of the efficiency ratio (ER), which is measured by the formula:
ER (i) = Signal (i) / Noise (i)
Where:
ER (i) - the current value of the efficiency ratio
Signal (i) = ABS (Price (i) - Price (i - N)) - the current signal value, the absolute value of the difference between the current price and the price N periods ago;
Noise (i) = Sum (ABS (Price (i) - Price (i-1)), N) - the current noise value, the sum of the absolute values of the difference between the price of the current and the price of the previous period for N periods.
With a strong trend, the efficiency ratio (ER) will tend to 1; in the absence of directional movement, it will be slightly more than 0. The resulting ER value is used in the exponential smoothing formula:
EMA (i) = Price (i) * SC + EMA (i-1) * (1 - SC)
Where:
SC = 2 / (n + 1) - smoothing constant EMA (smoothing constant), n - exponential sliding period;
EMA (i — 1) - previous value of EMA.
It is necessary that the smoothing coefficient for the fast market be the same as for the EMA with a period of 2 (fast SC = 2 / (2 + 1) = 0.6667), and for the period without a trend, the EMA period should be 30 (slow SC = 2 / (30 + 1) = 0.06452). Thus, a new scaled smoothing constant SSC is introduced:
SSC (i) = (ER (i) * (fast SC - slow SC) + slow SC
For a more effective effect of the resulting changing smoothing constant on the averaging period, Kaufman recommends squaring it.
The final formula for calculation:
AMA (i) = AMA (i-1) + (SSC (i) ^ 2) * (Price (i) - AMA (i-1))
Where:
AMA (i) - current AMA value;
AMA (i — 1) - previous AMA value;
SSC (i) is the current value of the changing smoothing constant.
Indicator settings
In the window, you can set the moving period and the display of entry/exit points: PeriodAMA, nFast, nSlow, G - a selection of the curve display period; dK - the number of displayed entry points on the chart.
Indicator signals
A buy signal is displayed as blue dots on the AMA line, and a sell signal is displayed as red dots. In addition, when choosing the optimal period for a traded asset, the AMA line also serves as a support and resistance line. If the price crosses the line, it can be a signal to change the current trend.
Conclusion
For those traders who are used to working with standard versions of moving averages, the AMA indicator can be a worthy alternative with obvious advantages. This tool is a good filter when building your own trading strategies.
Tip: Can’t open the downloaded archive file (ZIP or RAR)?
Try WinRAR for Windows or The Unarchiver for Mac .
Do you need help with installing this indicator into MT4 for Windows or Mac OS? Our guide HERE will help you.
