Author: Nikolay Kositsin
Forum on trading, automated trading systems and testing trading strategies
newdigital, 2014.07.13 12:00
Adaptive Moving Average
Adaptive moving average (AMA), as the name suggests is an adaptation of moving average.
It is designed to adapt according to the dynamic market as needed.
Simple moving average (SMA) and its cousins weighted moving averages (WMA) and exponential moving averages (EMA) all work
fantastic when the market is trending. However when the market is range bound they pick up a lot of market noise generating a lot of premature signals. Moreover, they are all inherently lagging in nature.
In a quest to remedy shortcomings of moving averages, Perry J. Kaufmann,
first introduced adaptive moving average in his book The Smarter
Trading: Improving Performance in Changing Markets.20-Day-SMA & AMA In Action:
Prior to Mr. Kaufmann's introduction of AMA, traders employed combination of more than a single moving average such as
The Double Crossover Method
and The Triple Crossover Method.
The reasons behind employing multiple combination of moving averages are based on the following facts:
So the genius in Kaufmann's AMA was a system smart enough to vary its
speed according to a combination of market direction and speed.
In another words, when the market is trending, AMA speeds up along with
the trend. When the market is range bound and does nothing
AMA slows down.
Thus it righteously earns the name "adaptive" as it self adjusts to market direction and speed.
Kaufmann's AMA achieves sense of market direction and speed by incoporating the efficiency ratio.
Following are the trading rules for the Adaptive Moving Average: