The is what is known as a filtering or smoothing indicator. Its primary purpose is to filter out insignificant fluctuations in the price of a security and accurately track whatever the existing trend is. It can also be used to identify price levels in a market.
It’s also sometimes used by technical analysts who adopt the Principle of analysis to help identify the beginning and end of each wave in a cycle.
The Indicator’s Primary Purpose – Riding a Trend
By filtering out “noise” – insignificant price movements that occur within a sustained, long-term trend – the is designed to help traders maintain a profitable market position throughout a sustained trend.
The draws its own that are created or adjusted only when there is a price movement greater than a designated percentage amount. The default value on most versions of the indicator is 5%, meaning that the will not register any fluctuation in price that is less than 5%. Traders and market analysts can, of course, set their own minimum percentage values for the indicator. Values between 6% and 10% are commonly used variations from the default 5% value.
By not reacting to all the minor, insignificant price moves that occur in day to day trading of a security, the ideally helps traders to avoid being fooled by temporary price moves into abandoning profitable positions and to stay focused on the overall trend that is in place.