Moving averages are tools very commonly used in technical analysis in trading. But have you ever heard about KAMA which is Kaufman Adaptive Moving Average? It will be the subject of today's article. So if it is new to you, or you want to systematise knowledge about it, I encourage you to continue reading.
What is an adaptive moving average?
Kaufman Adaptive Moving Average (KAMA) was designed by Perry Kaufman. It takes into account market volatility or noise. It follows the prices closely. You can recognise the overall trend with it, filter the movements of the price or identify time turning points.
Setting up the IQ Option chart with Kaufman Adaptive Moving Average
Log in to your trading account and go to the Chart Analysis icon. Find Moving Averages under the Indicators tab. Kaufman's Adaptive Moving Average will be among the other ones on the list on the right side. Click on it and it will be added to your chart.
Every indicator comes with its settings. You may, however, change them according to your needs. Perry Kaufman recommends setting the period at 10, the fast period at 2, and the slow period at 30.
How is Kaufman Adaptive Moving Average calculated?
The formula to calculate the Kaufman Adaptive Moving Average is complex and consists of 3 steps which we will discuss one by one.
Efficiency Ratio (ER)
The Efficiency Ratio oscillates between 0 and 1 and refers to the change in price in relation to its volatility within a given time interval.
ER = Change / Volatility
- Change = Absolute Value ( C – C(10 periods ago) )
- Volatility = Sum of absolute values of the last 10 price changes (C minus Previous C)
Smoothing Constant (SC)
sci = [ERi x (fastest – slowest) + slowest]2
fastest = 2 / (fastest moving average period + 1)
slowest = 2 / (slowest moving average period + 1)
Kaufman Adaptive Moving Average
The final formula is as follows:
KAMAi = KAMAi-1 + SCi x (Price – KAMAi-1)
Remember, you'll probably never have to count it. The platform itself counts the values for drawing the pointer line. We give the formula mainly so that you have a better understanding of the Kaufman Adaptive Moving Average.
How to trade with Kaufman Adaptive Moving Average
KAMA is a trend-following indicator. Similarly, as with a moving average, you can trade with crossovers. When the price crosses below or above Kaufman Adaptive Moving Average, you can expect a change in the direction of the trend. Naturally, there will be many whipsaws so apply an extra price or time filter. For example, you may wait until the cross is held for a couple of candles.
KAMA serves well as the overall trend indicator. Just check whether it is declining and lower lows are developing on the chart or it is growing and higher highs are formed. Decreasing KAMA means there is a downtrend in the market. When the indicator increases, there is an uptrend.
Adding two KAMAs with different settings may bring interesting results. The one with the parameters at 10, 5, 30 can help to filter the trend. Once you recognise the downtrend or the uptrend, you will look at the second KAMA (10, 2, 30) to wait for the crossover with the price.
Consider the exemplary GBPUSD chart below. The uptrend was identified with the help of Kaufman Adaptive Moving Average with the settings 10, 5, 30. Now, observe the second shorter-term KAMA line (10, 2, 30). When the price crosses the indicator's line but then moves back, you can open a long position.
Analogically, you can go short when you were able to define the downtrend with the longer-term KAMA(10, 5, 30) and then noticed pullbacks to the second line (10, 2, 30).
Kaufman Adaptive Moving Average is a trend-following indicator. Add it to your chart and modify its settings. You can identify the overall trend with it. You can trade crossovers with the price. Moreover, you can add an extra KAMA line with different parameters and open a transaction on pullbacks.
I always recommend a little bit of practice before you invest your money. The IQ Option demo account is a place that will be perfect as a training field. You do get virtual cash and you can use it with no time limits.
I hope you found today's article useful.
I wish you high earnings!
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