Moving averages are probably the most used of all indicators in Technical Analysis. They can be used for a variety of things and there are several ways that they can be used in trading strategies. The most common use of moving averages is to help determine if an instrument is trending or not. The aim of this page is not to delve too deep into moving average strategies or the use of moving averages but to explain the construction of them and the various different types of moving averages.
How many types of Moving Average are there?
There are a few different types of moving average and they should not be confused with each other. There are simple moving averages (SMA), exponential moving averages(EMA), Weighted moving averages (WMA).
Simple moving average. (SMA)
Now if you did some for of maths at school you may remember being taught about the mean, mode and median. Essentially the simple moving average is the mean of a sequence of numbers. Imagine the number sequence 10,11,12,13,14. There are 5 numbers in total. If we add them all together so 10+11+12+13+14=60 we get the total 60. If we then divide the total by the quantity of numbers we get the mean or average of those numbers. So 60/5=12. Therefore the average is 12. So how does this relate to simple moving averages in technical analysis. Well when calculating a simple moving average you first need to determine the number of time periods you want to calculate it over. Say for instance you wanted to calculate the 5 day SMA. You would need the price for the last 5 days. Lets say this data is 100, 105, 110, 108, 104. we add them together 100+105+110+108+104=527 then divide by the quantity 527/5=105.4. Therefore the simple moving average for the last 5 periods is 105.4. Obviously these days there is no need to calculate moving averages by hand almost all charting packages will allow you to add them to your chart. Most of the moving averages will be calculated on the close price but some charts will allow you to select which price to use for the SMA calculation (open, close, high, low).
Exponential moving average.(EMA)
Exponential moving averages are more complicated than simple moving averages. The exponential moving average gives more weight to the most recent price. If you imagine an exponential moving average has already been calculated and you need to recalculate it to include todays value then you would multiply todays value by a certain percentage and add it to yesterdays exponential moving average value multiplied by another percentage. Now this is a very simplistic explanation and if you would like to read more about the maths involved and get the correct calculation see wikipedias moving average page
So why would you want to use exponential moving averages over simple moving averages?
Obviously exponential moving averages give more weight to the most recent price action so some people deem them to be more useful as the most relevant price action is the most recent price action. I think it really comes down to personal preference when deciding what type of moving average to use. I would say the neither has the upper hand and both have their benefits. The best thing I can say is pick one and use that.
Weighted moving average. (WMA)
A weighted moving average also gives more weight to more recent prices however, it differs to the exponential moving average as the weight decreases in an arithmetical progression. What this basically means is that the weight decreases by the same amount between each moving average. For instance if the first MA has a weight of 20 the next might have a weight of 18, and the next 16, 14, 12 and so on. For a better explanation and to see the calculations involved see wikipedias moving average page.
