Stock market is all about price movements and there are a lot of tools that help you track those movements from time to time.
Two such tools are Simple Moving Average and Exponential Moving Average and they both work in different ways.
Simple Moving Average
A simple moving average is calculated by taking into average the price of a security over a specific
period of time. These are mostly based on the closing prices. A 5 day simple moving average is
a five day sum of the closing price divided by five.
Example of simple moving average is
Daily closing price: 15, 16, 17, 18, 19
Simple Moving Average is (15+16+17+18+19) / 5 = 17
Simple Moving Average line graph moves very slowly, hence there is a lag with respect to current day.
Exponential Moving Average
Exponential Average is calculated by using the recent prices having given more weighting than the previous prices. Thus, the EMA line moves much faster reducing the time lag with respect to current day.
The three steps to calculating the EMA are:
- SMA calculations.
- Calculating the multiplier for weighting the EMA.
- Calculate the current EMA.
The mathematical formula, in this case for calculating a 5 period EMA, looks like this:
SMA: 5-period sum ÷ 5
Calculating the weighting multiplier: [2 ÷ (selected time period + 1)] = [2 ÷ (5 + 1)] = 0.3333 or 33.33%
Calculating the EMA: [Closing price-EMA (previous day)] x multiplier + EMA (previous day)
The weighting given to the most recent price is greater for a shorter-period EMA than for a longer-period EMA. For example, an 18.18% multiplier is applied to the most recent price data for a 10 EMA.
Some key points about Moving Averages
- Moving Averages can be used to define the overall trend of the stock or market.
- Traders can use moving averages in devising their trading strategies
- Multiple EMAs can be used to create EMA RIBBON strategy to create profitable trading band
- The trend helps you trade but you can’t depend completely on it and make decisions
- Moving Averages may sometimes give you late indications due to time lag
Understanding the various trending tools are very important to do the right trade at the right time. To
learn more about the various trending tools and how you can trade better please contact us and we
would be happy to guide.
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