Moving Average Indicator

What is a Moving Average?

Using a moving average in statistics is a way of analysing data points by taking the standards of different subsets of the entire data set and calculating the average of each one. It is a stock indicator extensively employed in technical analysis in finance. A stock’s moving average is calculated to smooth out the price data by producing an average price that is constantly being updated. 

It’s not easy to predict stock market trends. Even though it is hard to anticipate the future movement of a given stock, employing technical analysis and research can help you create more accurate predictions. 

A rising moving average suggests an uptrend, whereas a falling moving average indicates a decline. Short-term moving averages crossing below longer-term moving averages is a bearish crossover, which could indicate a downward momentum. 

How to calculate moving average

Simple moving average: 

SMA=nA1​+A2​+…+An/n​​ 

where: 

A=Average in period n 

n=Number of time periods​ 

Exponential Moving Average: 

EMAt​=[Vt​×(1+ds​)]+EMAy​×[1−(1+ds​)] 

where: 

EMAt​=EMA today 

Vt​=Value today 

EMAy​=EMA yesterday 

s=Smoothing 

d=Number of days​ 

Types of Moving Averages

Simplifying Moving Average 

 Simple moving average (SMA) is computed by taking the arithmetic mean of a particular set of values over a predetermined time. This form of a moving average is also the most common type. To put it another way, a group of numbers, or prices in the case of financial instruments, are summed up, and then that total is divided by the total number of prices in the group. 

Moving average with an exponential scale (EMA) 

An example of a moving average is the exponential moving average, which differs from other moving averages in that it lends more significance to more recent prices to make the moving average more sensitive to new information. Before you can compute an exponential moving average (EMA), you must determine the simple moving average (SMA) for a given time. The next step is to determine the multiplier used for weighting the EMA.  

This factor is also known as the “smoothing factor,” and its calculation typically follows the formula [2/(selected period + 1)]. Therefore, the multiplier for a moving average of 20 days would be [2/(20+1)], which equals 0.0952. After that, you calculate the current value by adding the smoothing factor to the prior EMA and then taking the product of those two values. In light of this, the EMA assigns a greater weighting to more recent prices, whereas the SMA offers an equal weighting to all deals. 

SMA vs EMA

The Exponential Moving Average, also known as the EMA, and the Simple Moving Average, often known as the SMA, measure trends similarly. The interpretation of the two averages is the same, and both of them are used frequently by technical traders to smooth out price variations. This is another reason why the two averages are comparable to one another. 

The two measurements, however, do not correspond precisely to one another in every respect. The degree to which each indicator is sensitive to variations in the data it employs in its computation is the crucial distinction between a simple moving average and an exponential moving average (EMA). 

The Simple Moving Average (SMA) is used to determine price averages, whereas the Exponential Moving Average (EMA) lends more weight to recent data. The most recent price information will significantly impact the moving average, while older price information will have a lesser effect. 

More explicitly, the simple moving average offers equal weighting to all values, whereas the exponential moving average gives a higher weighting to recent prices. 

How do traders use moving averages?

A straightforward instrument for technical analysis, the moving average (MA) helps to smooth out price data by generating an average price continuously revised. The standard is calculated over a predetermined amount of time, such as 10 days, 20 minutes, 30 weeks, or any other amount of time that the trader determines. Regarding trading, using a moving average can provide you with several benefits, and you also have choices on the moving average to apply. 

Day traders looking for an edge in trading the market from both the long and short sides might find the appropriate inputs in the form of 5-, 8-, and 13-bar simple moving averages. Moving averages also function very well as filters, indicating to market participants with quick fingers when the level of risk is too high for intraday entries. 

Moving average trading strategies

Trading Strategy Based on Moving Averages 

The exponential moving average (EMA) is used in this particular trading technique for moving averages because of the EMA’s capacity to react rapidly to shifts in price. The strategy is as follows. 

• On a chart that’s 15 minutes long, draw three exponential moving averages: one with five periods, one with 20 periods, and one with 50 periods. 
• When the five-period EMA crosses from below to above the 20-period EMA and the price, five, and 20-period EMAs are above the 50-period EMA, it is an excellent time to buy the security. 

• Sell when the five-period EMA crosses from above to below the 20-period EMA, and sell again when both the price and EMAs are below the 50-period EMA. This is the signal for a sell trade. 
• If you are entering a buy trade, position the initial stop-loss order so that it is below the 20-period EMA; alternatively, place it approximately ten pips away from the entry price. 
• When the transaction is ten pips in the black, you have the option of breaking even by moving the stop-loss order to break even. 
• Think about setting a profit target of 20 pip, or another option is to pull out of the trade when the five-period drops below the 20-period if you are long or when the five-period climbs above the 20 if you are short. 

Frequently Asked Questions