Definition:
A Moving Average or MA is a technical indicator that shows the average value of a financial instrument or commodity over a set period of time. The MAs will generally be plotted directly over the price action they are calculated for, and can also be computed on other indicators.
The four major types of moving averages that are in common usage among traders are:
- Simple Moving Average or SMA – this type of moving average is calculated by adding the closing price of the instrument for a set number of periods and then dividing the total by the number of periods.
- Exponential Moving Average or EMA – an exponential moving average is the same as a simple moving average except that the more recent data is given more weight while older data is decreased exponentially.
- Smoothed Moving Average or SMMA – combines elements of both the simple moving average and the exponential moving average. The SMMA gives equal weighting to recent prices as to historic prices. Nevertheless, the calculation does not have a fixed period reference but instead takes all available data into account. Subtracting the previous day’s smoothed moving average from the present price and adding the result to the previous day’s smoothed moving average will give you the present smoothed moving average.
- Linear Weighted Moving Average or LWMA - this MA is calculated by taking all of the price entries over the time period and then multiplying each one by the position of that particular data point and then dividing the number by the sum of the number of periods. In other words, in a 3-day weighted average, today’s price would be multiplied by 3, yesterday’s price by 2 and then they would be added to the day before yesterday’s price, and then that sum would be divided by the sum of the multipliers.
Moving averages are generally lagging indicators and are most effective in identifying and confirming trends as well as identifying major support and resistance levels. In order to help discern whether an instrument is trending or ranging, using the MAs in combination with a trend indicator such as the ADX or Average Directional Index may improve results.
Sample Chart:
Usage:
Many traders find Moving Averages extremely useful technical indicators, and they are employed for a variety of different purposes in technical analysis. The main reason traders use moving averages is to identify and confirm trends. Direction, location and crossover are the three principal methods involving Moving Averages that are used to identify trends.
The first technique for identifying a trend using MAs is direction. If the MA is rising, then the market would be considered to be in an up-trend over the time period covered by the Moving Average. Conversely, if the MA is declining, then the trend would be considered down for that period.
The first technique for identifying a trend using MAs is direction. If the MA is rising, then the market would be considered to be in an up-trend over the time period covered by the Moving Average. Conversely, if the MA is declining, then the trend would be considered down for that period.
The third technique involves two moving averages, one of shorter duration than the other. If the shorter-term MA is above the longer-term MA, then the trend is considered up. If the shorter-term MA is below the longer-term MA, then the trend would be considered down.
Calculation Method:
Define:
- n= the number of the time period bar in question.
- N= the number of time periods in the averaging process.
- Close(n)= The closing price at the end of time period n.
- SMA(n)= Simple Moving Average of price over n periods.
- EMA(n)= Exponential Moving Average of price over n periods.
- LWMA(n)= Weighted Moving Average of price over n periods.
- P= The percent of the exponential moving average.
- SUM(n, N)= the sum of N weighting coefficients at time period n.
Calculate:
Simple Moving Average or SMA:
A simple moving average is also known as an arithmetical average and involves adding the closing prices over a certain number of individual time periods, and then dividing by the number of periods.
SMA(n) = SUM(Close(n), N) / N
Exponential Moving Average or EMA:
A P-percent exponential moving average at time period n is calculated as follows:
EMA(n) = (Close(n) * P) + (EMA(n - 1) * (100 - P))
Smoothed Moving Average SMMA:
SMMA(n) = [SMMA(n - 1) * (N - 1) + Close(n)] / N
Linear Weighted Moving Average or LWMA:
LWMA(n) = SUM(Close(n)*n, N) / SUM(n, N)
Practice Moving Averages Trading
Technical analysis with Moving Averages is a demanding skill that requires practice to master. We recommend that you use a demo account to train yourself for free before applying your skills to real money trading.
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