Kaufman's Adaptive Moving Average (KAMA) is a technical indicator developed by Perry Kaufman that is used to identify trends in financial markets. The KAMA is a moving average that adapts to market volatility, making it more responsive to short-term price movements and less responsive to long-term price movements.
The KAMA is calculated using a combination of a simple moving average, an efficiency ratio, and a volatility ratio. The simple moving average is used as the base for the KAMA, and the efficiency and volatility ratios are used to adjust the moving average's sensitivity to market volatility.
The efficiency ratio compares the current price to the price of a certain number of periods ago. The volatility ratio compares the current price change to the price change of a certain number of periods ago. Both ratios are calculated using the difference between the current price and the simple moving average.
The KAMA is a responsive indicator that can be used to identify trends in both bullish and bearish markets. When the KAMA is rising, it suggests that the market is in an uptrend, and when the KAMA is falling, it suggests that the market is in a downtrend.
The KAMA can be used in several ways to generate trading signals. One of the most common is to look for crossovers of the KAMA above or below the price. When the KAMA crosses above the price, it generates a bullish signal, and when it crosses below the price, it generates a bearish signal.
The KAMA can also be used to identify divergences between the KAMA and price action. When the KAMA is making new highs while price is failing to do so, it can be a bearish divergence and a warning of a potential trend reversal. Similarly, when the KAMA is making new lows while price is failing to do so, it can be a bullish divergence and a warning of a potential trend reversal.
The KAMA can be used in combination with other indicators and analysis techniques to generate more robust trading signals.
It's important to note that the KAMA is a lagging indicator, meaning that it is based on past price data and may not always provide accurate predictions about future price movements. As with any indicator, it is best to use the KAMA in conjunction with other indicators and analysis techniques to confirm signals and get a better understanding of the market conditions.