Hull Moving Average: Meaning, Calculation, Limitations and More

In this article, we will discuss

Hull Moving Average: Meaning, Calculation, Limitations and more - Banner

For anyone interested in technical analysis, the first and most fundamental aspect to focus on is the direction of historical price movements. Moving Averages (MAs) help do this easily because they essentially make the price action smoother. Traditional MAs include the Simple Moving Average (SMA) and the Exponential Moving Average (EMA).

While they can be quite useful, the results of such MAs include a noticeable lag. Let us explore this further.

The Problem of Price Lags in Traditional Moving Averages

To understand how traditional moving averages lead to price lags, let us discuss an example. Consider the following closing prices for a stock over 10 days:

  • Rs. 100
  • Rs. 98
  • Rs. 97
  • Rs. 102
  • Rs. 101
  • Rs. 103
  • Rs. 99
  • Rs. 95
  • Rs. 98
  • Rs. 104

The total of these prices comes out to be Rs. 997. This leads us to an SMA of Rs. 99.70 (i.e. Rs. 997 ÷ 10 periods).

Now suppose that on day 11, the price jumps to Rs. 110. The new 10-day price sum in this case will be Rs. 1007 (because we drop Rs. 100 and add Rs. 110 instead). This leads us to a new 10-day SMA of Rs. 100.70.

As you can see, even though the price jumps significantly from Rs. 104 to Rs. 110 in one day, the SMA only shows a modest increase from Rs. 99.70 to Rs. 100.70. This lag is because traditional moving averages give the same weightage to the most recent price and to the oldest price in the time frame concerned. Consequently, they do not reflect immediate market conditions accurately.

The Hull Moving Average (HMA) attempts to change this.

The Hull Moving Average: An Introduction

Back in 2005, Australian stock trader Alan Hull modified existing MAs to develop a technical analysis tool that addressed the lags caused by traditional indicators. This tool, named the Hull Moving Average after its creator, is a more accurate indicator of the current direction and momentum of the price movement. Simultaneously, it also smooths out the price action, so you can make more informed and agile trading decisions.

When you track the HMA, you can get a clearer picture of two key aspects:

  • The direction in which the price of a stock or security is moving
  • The amount by which this move occurs

Based on these key insights, you can decide which type of position to take in your trade (long or short), the price point of entry and the stop-loss levels).

Bridging the Gap with the HMA

In this section, we tackle one crucial question: How does the HMA help eliminate lags and smooth out the price action in the chart? Fundamentally, the HMA gives more weightage to recent price changes. So, because of how the weight is distributed across price data, the lag is greatly reduced and the HMA is more reactive to newer price movements.

Also, this technical tool is calculated using a two-step process and uses two Weighted Moving Averages (WMAs) — one for a longer period and the other for a shorter period. The long-period WMA makes it easier to eliminate price data fluctuations, so you have a smoother price path to track. The short-period WMA minimises the lag in the indicator, so you can get to know with more clarity what the recent price changes are like.

How to Calculate the HMA

To better understand how the HMA works the way it does, you need to see how it is calculated. Although many charting and trading platforms now make the HMA available at your fingertips, getting to know the computation process can help you appreciate this technical tool better and use it more effectively.

Let us check out the steps involved in calculating the HMA and then summarise it using the Hull Moving Average formula.

  • Step 1: Identify the Time Frame

The first step is to identify the time frame over which you want to compute the Hull MA. Originally, Alan Hull developed the technical tool with a suggested time frame of 16 trading periods. However, you can use any time frame that you choose. Let’s call this period ‘n.’

  • Step 2: Compute the Longer WMA

You need to then calculate the WMA for the chosen time frame. This is the longer of the two WMAs used in computing Hull’s moving average.

  • Step 3: Compute the Shorter WMA

Then, compute the WMA for half the time frame chosen (i.e. n/2). This is the shorter of the two WMAs that you need to compute the HMA. 

  • Step 4: Find the Difference

Double the shorter WMA and, from the resulting figure, subtract the longer WMA. In other words, this is what you need to do mathematically.

Difference = (2 x WMAn/2) — WMAn

The resulting value is the raw HMA that has not been smoothed out to reflect the price action more efficiently. To do this, we need to cover one more step, as outlined below.

  • Step 5: Calculate the HMA

The final HMA is calculated as the WMA of the above difference over a period equal to the square root of ‘n.’ If this square root is a decimal, you can round it up to the next highest whole number. The HMA formula as per the above logic is as follows:

HMA = WMAsquare root of n(difference)

Or, 

HMA = WMAsquare root of n[(2 x WMAn/2) — WMAn]

This sums up the process of calculating the Hull Moving Average. Needless to say, computing the average each time can be time-consuming and prone to errors. So, you can use trading platforms that offer this data live. However, now that you know the rationale behind computing the HMA, you can understand its use cases better.

Different Ways to Use the HMA

For short-term traders with a focus on technical analysis, the Hull Moving Average can be more useful than traditional MAs. If you are also keen on leveraging immediate price movements in the market, you can use the HMA to pinpoint the prevailing market trend, check where the support and resistance levels are forming and identify potential entry points for long or short trades.

Beyond this, there are many specific moving average strategies that you can use, as outlined below.

  • Trend Following Trades:

Here, you use the HMA to identify a prevailing trend and take a long or short position accordingly. If the HMA trends upward, it indicates a potentially bullish market, so you can initiate a buy trade. Conversely, if the HMA trends downward, suggesting a potentially bearish market, you may want to initiate a short position.

  • Filter Trading Strategy:

One of the most common issues in technical analysis is the prevalence of false signals. The HMA can help you avoid this pitfall by filtering out the noise. You can set a threshold a few points above or below the HMA to distinguish genuine market movements from random fluctuations and false price movements.

  • Divergence Trading Strategy:

In this type of moving average strategy, you need to focus on the divergence or discrepancy between the HMA and the ongoing price action. If the price makes new highs (or new lows) but the HMA does not, it may be a sign that the prevailing trend is losing momentum. You can use the divergence strategy to prepare for potential trend reversals in the market.;

  • HMA Crossover Strategy: 

You can also monitor a longer and a shorter HMA and find trade entry or exit points based on how the two HMAs cross over one another. Typically, a shorter HMA crossing above a longer HMA means the price is rising rapidly, giving a buying opportunity. Similarly, if the shorter HMA crosses below the longer HMA, it may be a sell signal.

  • HMA Breakout Strategy:

You can use the breakout strategy to capitalise on price breakouts early on — just when the price breaches an existing support or resistance level. A breakout above the HMA could indicate a possibly strong upward trend, thus giving a buy signal. On the other hand, a breakdown or dip below the chosen HMA could be a sell signal.

HMA: Advantages and Disadvantages

Before you use the HMA in your trades, you need to also be aware of the upsides and downsides of this trading tool. This will help you capitalise on its advantages and work around its limitations.

The main benefits of the HMA include the following:

  • It is highly responsive to recent price data.
  • It smooths out price action substantially.
  • It can be adapted to different time frames, market conditions and trading goals.
  • It is easy to interpret.
  • It can be used for a wide range of trading strategies.

However, on the flip side, the HMA has some limitations too, as outlined below:

  • It may occasionally generate false signals.
  • It may be highly sensitive to whipsaw price movements.
  • It is an advanced indicator that beginners may find hard to grasp.

Conclusion

This concludes our guide on what the Hull Moving Average is and how you can use it to make more informed trades in the market. However, as with all technical indicators, ensure that you do not rely solely on one tool. It is best to use a combination of indicators to understand the market condition comprehensively before entering or exiting a position.

Disclaimer: INVESTMENT IN SECURITIES MARKET ARE SUBJECT TO MARKET RISKS, READ ALL THE RELATED DOCUMENTS CAREFULLY BEFORE INVESTING.
The asset classes and securities quoted in the film are exemplary and are not recommendatory.
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