The Adaptive Moving Average (AMA) is a technical Indicator that is used for constructing a moving average that has low sensitivity to market noise and is characterized by implementing minimal lag for trend detection. This indicator was developed and described by Perry Kaufman in his book “Smarter Trading”. The Adaptive Moving Average is not as popular as the commonly used moving averages but can be a useful additional filter when implemented within forex trading strategies.
What is the Adaptive Moving Average?
Moving averages are among the most common trend indicators that have been used to analyze the price charts since the middle of the last century. It’s not necessary to talk a lot about the fact that financial markets have changed significantly over the past few decades. The changes affected both the volatility and liquidity of instruments. Also, the decentralized over-the-counter foreign exchange market, better known as forex, gained wide popularity, and many new financial instruments for trading appeared. Despite these changes, moving averages are still actively used in technical analysis. Three common types of trend indicators are integrated by default into almost every trading platform:
- simple moving average
- exponential moving average
- linearly weighted moving average
The moving averages differ in the principle of averaging the value of an asset over the period specified in the input parameters. They are united by one standard and rather a significant drawback – for insignificant periods, the lines are susceptible to such changes in the asset value and can be delayed in showing the current price action. This problem is solved by the adaptive moving average, which was developed by the American expert in the field of technical analysis of price charts, Perry Kaufman.
He described the algorithm of his indicator in detail in the book “Smart Trading”, which may be familiar with some of the more experienced traders amongst you. Adaptive sliding visually practically does not differ from standard analogs. Kaufman changed the algorithm for calculating the performance of classic moving averages, adding to it an efficiency coefficient as a variable, as well as constants for fast and slow averaging of the asset value over a specified period.
This allows the indicator to determine the relationship between the volatility of the selected currency pair and the direction of the movement of the price chart, in other words, when consolidating, the moving slows down, providing a high-quality filter of false signals.
When a pronounced trend is formed, the period is automatically shortened, which allows the trader to react accordingly. Today, there are several adaptive moving average modifications. The changes made by interested traders concerned the visual design exclusively.
Adaptive moving is recommended for trading base currency pairs and stock indices although it can be used on any trading instrument and chart time frame. Today, many trading brokers provide online trading services to retail clients around the globe. The adaptive moving average is not included in the standard analytical tools for most forex trading platforms although you can quite easily find it to download.
If you are using the MetaTrader 4 platform, the indicator will need to be downloaded and copied to the root folder of the MT4 terminal yourself. After that, restart the terminal and you will find the adaptive moving average in the user indicators section. When transferring an adaptive system moving onto the price chart, it will be proposed to make changes to the standard input parameters set by the developers. If you would like to experiment with the inputs you are free to do so.
The main parameters of the adaptive moving average include:
- Adapted rolling period (from 5 to 20)
- Period of the fast-moving constant (from 1 to 5)
- Period of a slow constant (range 25-45)
How to use the Adaptive Moving Average?
To open a buy order, we will need to wait for confirmation from the indicators, namely:
- The price is above the adaptive moving average.
- A signal is formed on the moving average to open an order in the form of a blue dot.
- It is essential to wait for the candle to close before entering the market.
To open a sell order, the indicator signals are opposite:
- The graph is plotted below the adaptive moving average.
- A signal is formed on the moving average to open an order in the form of a red dot.
- It is essential to wait for the candle to close before entering the market.
When trading with this adaptive moving average strategy, compliance with the rules of money management and placing a safety stop loss is important. Stop losses can be set at the nearest local high/low but exact levels will depend on your own trading strategy rules.
Please pay attention to the highlighted part of the screenshot below. There are no marks on it since consolidation is observed on the chart.
The adaptive moving average with standard parameters can give several false signals to open an order. Therefore, we could use any oscillator with it such as the Stochastic Oscillator to filter the false signals and look for overbough/sold market conditions in line with the overall trend.
Adaptive Moving Average trading strategy
In this adaptive moving average strategy example, we will use the stochastic oscillator along with the adaptive moving average indicator to form a simple trading strategy.
Adaptive Moving Average buy trade setup
- We can consider buying an asset if the adaptive moving average dots turn blue from red.
- We await further confirmation from the stochastic oscillator. The value should be near the oversold area.
- Stop loss could be below the local low while take profit could be an immediate resistance level, when the stochastic turns to overbought condition or adaptive moving average changes direction.
Adaptive Moving Average sell trade setup
- We can consider selling an asset if the adaptive moving average dots turn red from blue.
- We await further confirmation from the stochastic oscillator. The value should be near the overbought area.
- Stop loss could be above the high while take profit could be an immediate support level, when the stochastic turns to oversold condition or adaptive moving average changes direction.
Adaptive Moving Average conclusion
The Adaptive Moving Average (AMA) can be a very useful trend indicator when using the right settings. The presented trading strategy will allow you to start trading with the indicator although it is very important that every trader needs to develop the necessary skills through a demo account before working with real funds. It can take months and even years of practice to be prepared for trading forex online with a live account.
I would prefer to use the majority of technical indicators such as the Adaptive Moving Average on the 1-hour charts and above. I tend to find that these charts contain less market noise than the lower time frames and thus give more reliable signals for my forex trading strategies. This also means that I spend less time staring at charts and can also set alert notifications to let me know when price has reached certain levels or a particular indicator value has been reached.
The Adaptive Moving Average is just one indicator amongst thousands. I would not build a trading system alone, but rather combine with other technical indicators such as moving averages, Parabolic SAR, Stochastic Oscillator, RSI, ADX and price action analysis.
Of course, every trading system will generate false signals which is why money management is so important. I would personally be implementing sensible money management and only take traders that give me a favorable risk to reward ratio, ideally of at least 1:3. This means that one losing trade does not wipe out consecutive winners.
The methods of implementing the Adaptive Moving Average into a trading strategy that are outlined within this article are just ideas. I would always ensure that I have good money management, trading discipline and a trading plan when using any forex strategy.
Furthermore, I would combine multiple technical analysis, fundamental analysis, price action analysis and sentiment analysis to filter all entries. You should trade forex in a way that suits your own individual style, needs and goals.
If you would like to practice trading with the Adaptive Moving Average, you can open an account with a forex broker and download a trading platform. If you are looking for a forex broker, you may wish to view my best forex brokers for some inspiration.