V.13:06: (267): SIDEBAR: Adaptive Moving Average by Bruce Faber
Perry Kaufman points out in Smarter Trading that if you could achieve only one goal in analyzing the price of
investments, it should be to identify the direction, or trend, of the market involved. Further, he writes that "everyone wants a short-term, fast trading trend that works without large losses. That combination does not exist." It is possible to have fast trading trends in which one must get in or out of the market quickly, but these have the distinct disadvantage of being whipsawed by market noise when the market is volatile in a sideways trending market. During these periods, the trader is jumping in and out of positions with no profit-making trend in sight. However, it is possible to avoid the noise by using very long moving averages. These are little affected by the day-to-day changes in price, but they also miss much of the profit to be gained, or saved as the case may be, by the lag between the time that the trend actually changes and the moving average gives a buy or sell signal.
In an attempt to overcome the problem of noise and still be able to get closer to the actual change of the trend,
Kaufman developed an indicator that adapts to market movement. This indicator, an adaptive moving average
(AMA), moves very slowly when markets are moving sideways but moves swiftly when the markets also move swiftly, change directions or break out of a trading range.