Summary: A moving average is a stock indicator that is used in capital markets. It is majorly leveraged for technical analysis. It is derived from calculating a series of means from definite time periods of numbers or values. It is apt for tracking trends as new data is constantly updated as well as for gaining insights into market movements. An exponential moving average is often preferred by technical analysts to a simple moving average as it provides more weight to recent prices and comes with a clearer response to the latest trends.
A moving average (MA) is calculated in order to smooth out the price data with the help of constantly updated average price. By understanding and calculating the same, traders can analyse and mitigate the effects of short-term fluctuations on the stock price over a particular period.
What are moving averages?
MAs are calculated to recognise the trend direction of a certain stock and understand its support and resistance levels. It is calculated based on past prices. The lag is directly proportional to the period for the MA. For instance, a 200-day MA will have more lag than a 20-day MA as it consists of past 200 days’ prices. Investors and traders follow 50-day and 200-day MA figures, which are known as important trading signals.
Investors can choose various spans of varying lengths for the calculation of MAs based on trading objectives. Calculating long-term MA is better for patient investors who are ready to wait. On the other hand, shorter MAs are used for short-term trading.
Technical analysis can make it much easier for traders to forecast stock price movements. An increasing MA refers to a security in an uptrend, while a decreasing MA reflects a downtrend.
- Upward momentum is recognised with a bullish crossover, which takes place when a short-term MA surpasses a long-term MA.
- Similarly, downward momentum is related to a bearish crossover that happens when a short-term MA slips below a long-term MA.
Types of moving averages
There are two types of MAs – the simple moving average (SMA) and the exponential moving average (EMA). SMAs leverage simple arithmetic average of prices over a duration. On the other hand, EMAs emphasise recent prices over past prices.
| Consideration | SMA | EMA |
| Definition | A SMA is a statistical calculation that determines the arithmetic mean of a set of data points over a specified time period or data count, providing a smoothed trend indicator. | An EMA is a statistical calculation that assigns greater weight to recent data points, providing a smoothed trend indicator that reacts more sensitively to recent changes. |
| Methodology | You should take the arithmetic mean of a particular set of values over a particular time period to calculate the SMA. A set of numerical or cost of stocks are added and then divided by the number of prices in the set. | The SMA needs to get calculated first when you are calculating the EMA. After that, you should calculate the multiplier for weighting the EMA, which is also called the smoothing factor. |
| Formula | SMA=A1+A2+…+An/n A: Average in period n n: Number of time periods | EMAt=[Vt×(1+ds)]+EMAy×[1−(1+ds)] EMAt: EMA today Vt: Value today EMAy: EMA yesterday S: Smoothing D: Number of days |
| Differentiator | The SMA applies equal weighting to all observations in the dataset. Traders can easily calculate it by considering the arithmetic mean of prices in the time period. | The EMA has more sensitivity to recent price point fluctuations. Thus, EMA is more responsive to the latest price changes. |
A classic example of a moving average
MA is calculated based on SMA or EMA. Here is a classic example of the SMA of a security with the below-mentioned closing prices over a span of 15 days:
- Week 1 (5 days): 20, 22, 24, 25, 23
- Week 2 (5 days): 26, 28, 26, 29, 27
- Week 3 (5 days): 28, 30, 27, 29, 28
A 10-day MA refers to the averaging out of the closing prices for the initial ten days. The next data point will drop the earliest price and then add the price on the 11th day before taking the average. If you are looking for technical indicators, then you can check the Bollinger Band. It provides two standard deviations away from a SMA.
Streamline your investments with the help of an expert analyst
If you are an investor, then you must understand how MAs work and how it can help you with your investments. Take your time, research well, and seek expert guidance to deep-dive into the market. A MA is commonly used in technical analysis of shares. It is used to smoothen out price data, thereby forming a constantly updated average price. A rising and falling MA reflects securities in an uptrend and downtrend, respectively.
Professionals can enlighten you in the best possible ways so that you can choose the right investment tools at the right time. Make informed decisions after consulting our specialists.
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