A technical indicator used by the analysts to determine the direction of a trend and minimize the impact of unexpected price increases.
What is Moving Average ?
A moving average is a technical indicator used by the market analysts and investors to determine the direction of a trend.
It sums the data points of a financial security over a given time period and divides the sum by the average number of data pointsit is called a “moving” average.
Because it is constantly recalculated based on the latest price data.
Analysts use moving averages to examine the support and resistance by evaluating the movements of an asset’s price.
A moving average reflects the previous price action or movement of the security.
Analysts or investors use the information to determine the likely direction of an asset’s price it is called a lagging indicator.
Because it follows the price action of the underlying asset to generate a signal or show the direction of a given trend.
Types of Moving Averages
1.Simple Moving Average ( SMA )
2 .Exponential Moving Average ( EMA )
1.Simple Moving Average( SMA )
A simple moving average (SMA) is a simple technical indicator obtained by the summing.
The most recent data points in a particular set and dividing by the total number of time periods.
Traders use the SMA indicator to generate the signals about when to enter or exit the market.
An SMA appears lagging because it is based on the past price data for a specific period.
It is calculated for the different types of prices such as high, low, open and close.
In financial markets, analysts and investors use the SMA indicator to determine buy and sell signals for the securities.
SMA helps to identify the support and resistance prices to get signals of where to enter or exit a trade.
When generating the SMA, traders first calculate this average by adding the prices for a given period.
Dividing the sum by the total number of periods then the information is plotted on a graph.
The simple moving average formula is written as follows:
SMA = (A1 + A2 + ……..An) / n
● A is the average over n periods
● N is the number of periods
An example of a simple moving average
Tom, a stock trader, wants to calculate a simple moving average for stock ABC by looking at the stock’s closing prices over the past five days.
Stock ABC’s closing prices for the past five days were as follows:
• $23, $23.40, $23.20, $24 and $25.50.
SMA is calculated as follows:
• SMA = ($23 + $23.40 + $23.20 + $24 + $25.50) / 5
•SMA = $23.82
2.Exponential Moving Average (EMA)
Another type of moving average is the exponential moving average (EMA)
It gives more weight to the recent price points to make it more responsive to recent data points.
An exponential moving average is more responsive to the recent price changes compared to a simple moving average. which applies equal weight to all price changes over a given period.
While calculating the exponential moving average, the following three steps are used:
- First calculate the simple moving average for the given period.
The EMA should start anywhere and the simple moving average of the previous period is used as the EMA.
It is obtained by taking the sum of the closing prices of the security for the given period in question and dividing the sum by the number of periods.
- Calculate the coefficient for weighting the exponential moving average
The formula for calculating the coefficient is as follows:
●Multiplier = [2 / (selected time period + 1)]
For example, if the query period is 10, the coefficient is calculated as follows:
●Coefficient = [2 / (10+1)] = 0.1818
- The final step is calculate the current exponential moving average.
The final step calculates the current EMA by taking the period from the initial EMA.
The most recent time period using the price, multiplier and previous period’s EMA value.
It is calculated using the following formula:
●Current EMA = [Closing Price – EMA (Previous Period)] xMultiplier + EMA (Previous Period)
The weighting given to recent price data is higher for the longer-term EMA than for the shorter-term EMA.
A multiplier of 18.18% is applied to the recent price points of the 10-period EMA.
while a multiplier of 9.52% is applied to the recent price points of the 20-period EMA.
Exponential Moving Average vs. Simple Moving Average
The main difference between the two technical indicators is the sensitivity they place on price changes.
The exponential moving average shows more sensitivity to recent price changes.
It makes more responsive to the latest price changes of the EMA.
The formula for calculating the EMA is complex, but most charting tools make it easy for traders to follow the EMA.
In contrast, SMA applies equal weight to all observations in a data set. It is easy to calculate, obtained by taking the arithmetic mean of the prices during the period in question.
● A moving average is a technical indicator used by investors and traders to determine the trend direction of securities.
●It is calculated by adding all the data points in a given time period and dividing the sum by the number of time periods.
●Moving averages can also help technical traders to generate the trading signals.