Adaptive Moving Average (AMA): A Trading Signal Explained

The adaptive moving average (AMA) is a variation on the exponential moving average (EMA). It is an effort to deal with the inherent problems that have always plagued moving averages when being used to produce trading signals. Moving averages are following trend indicators that can be used to produce trading signals when prices cross over the moving average line. A perplexing problem for averages is when the market becomes range-bound, in a consolidation pattern. This produces many small gains and losses. 

Exponential Moving Average (EMA)

The EMA is a weighted average that tries to smooth out the market variations while staying close to the price action. It does this by using a constant that gives more weight to the most recent price data. This significantly reduces lag over the simple moving average. It still produces a lag that results in many losing trades when used for trading signals. 

Adaptive Moving Average (AMA)

The AMA tries to improve this by replacing the weight with a volatility adjusted constant usiing an efficiency ratio (ER). This produces another kind of trend smoothing line that still possesses the drawbacks of moving averages and all of the other lagging indicators.