Learn about investing, trading, retirement, banking, personal finance and more.
Moving averages are important components of many technical indicators. A simple moving average determines the average of a range of closing prices for a security or index for a specific period of time. An exponential moving average is a moving average that gives more weight to the most recent data. Simple moving averages are not weighted for time the way that exponential moving averages are, which has the effect of snapping the chart to the most current information, while simple moving averages have lag.
A Simple Moving Average (SMA) is calculated by taking the average of security prices over a specific interval of time, such as 15 days, and repeating the calculation again and again as each new day closes. As the name suggests, the average moves and changes with time – as new data becomes available, old data is discarded. A 15-day moving average, for example, computes the average using only the most recent fifteen days of prices. As the subsequent 15-day moving averages are plotted, we end up with a 15-day moving average line.
For example, suppose the stock price for company ABC were $3, $4, $5, and $6 on March 1st, 2nd, 3rd, and 4th (respectively). The 3-day SMA on March 3rd was ($3 + $4 + $5)/3 = $4, while on March 4th, the 3-day SMA was ($4 + $5 + $6)/3 = $5.
Simple moving averages are useful to traders because they smooth out volatility, which makes trends clearer. Its ability to calculate different time periods is also useful, but traders should be aware that longer time frames mean smoother SMAs, while shorter periods are more reactive (though also more reflective of the prices used in calculation).
The SMA does have some limitations. Some traders maintain that because it gives equal weight to any day in a given range, it is not as reflective of current trends. An additional school of thought believes its reliance on historical data means nothing – the principle of market efficiency means current data is not useful for indicating future direction.
An Exponential Moving Average (EMA) compensates for price lag by weighting recent prices more heavily. As a result, the EMA will follow current price movements more closely, rather than lagging because of the equal weighting given to old data in an SMA.
The formula for an EMA is as follows:
EMA = (Closing price – EMA previous day) x multiplier + EMA previous day.
The multiplier is calculated as follows: Multiplier = (2/(# of time periods + 1))
In the first calculation, an SMA is used as the previous day’s EMA.
EMAs work well with other indicators, as they can confirm the validity of market trends and movements as well as identify biases – they are also useful to short-term traders because of their ability to reduce lag.
The EMA is not perfect. Similar to the SMA, a school of thought around true market efficiency devalues the EMA because of its reliance on historical data – if the data is not current, it tells us nothing about how an asset may trend in the future. Some traders also believe that EMAs are biased by virtue of weighting recent data more heavily, which can lead to false signals.
Traders using moving averages are always on the lookout for certain indicators, including two basics: the Golden Cross and the Death Cross. The Golden Cross refers to a breakout candlestick pattern when the short term 50-day moving average for a security exceeds its long term 200-day average, backed by high trading volumes. Investors typically interpret this crossover as a harbinger of a bull market, and its impact can reverberate throughout index sectors.
The Death Cross is a chart pattern indicating when a security’s short-term moving average crosses underneath its long-term counterpart, typically followed by an increase in trading volume. Investors use a death cross, the inverse of a golden cross, as a tool to identify incoming bear markets, most commonly using long-term 50-day and 200-day moving averages to detect the pattern.
Simple and exponential moving averages are just two of the many tools that make up technical analysis in trading. Which indicator or methodology a trader decides to use usually depends on their experience, skillset, and the quality of the tools (including artificial intelligence with Tickeron) available to help them find trade ideas.
Discover the world of alternative funds, a unique investment avenue offering exposure to non-traditional assets like commodities, real estate, and private equity. Learn how these funds can diversify your portfolio, hedge against market volatility, and potentially enhance returns.
Explore the concept of market disequilibrium, its causes, and implications. Learn how tools like technical analysis and AI can help traders identify these market imbalances and make profitable decisions. Understand the role of moving averages in predicting market trends
Uncover the power of compounding in investing and personal finance. Learn how earnings reinvested over time can generate significant returns, the role of compound interest, dividend reinvestment, and capital gains. Start early, be patient, and make smart financial decisions to maximize your returns
Technical analysis is a method of evaluating the worth and probable future direction of security prices using charts...
Discover how trading models reduce emotions in financial decisions. Learn about trend following, mean reversion, breakout, scalping, and news-based models. Benefit from consistency, backtesting, automation, and risk management. Be aware of limitations like overfitting and technical issues.
Explore the complexities of foreign aid, from its diverse forms such as financial assistance, humanitarian aid, to its motivations and global impact. Understand how it serves as a lifeline for struggling nations and a strategic tool for donor countries.
Dive into the world of social media, its definitions, impacts on personal life, business, and governance, plus a list of popular platforms. Learn how it shapes global communication, fosters community, and drives marketing strategies with more than 4.7 billion users.
Discover the top online brokerage accounts for 2023. Fidelity, TD Ameritrade, Interactive Brokers, and tastyworks offer diverse options, from low costs to options trading. Find the ideal platform for your investment needs and goals
Unlock the world of extended trading in finance and stock markets. Delve into the advantages and potential pitfalls. Learn about the timing, market segmentation, and the impact of Electronic Communication Networks (ECNs). Understand the unique opportunities and risks involved in trading...
Discover how AI Screener is leveling the playing field for retail investors, offering advanced AI tools for stock analysis previously reserved for hedge funds. Explore practical tips for utilizing this AI-powered platform to analyze stock categories, identify market trends