Moving Averages Technical Analysis

ny stocks technical analysis applications averages arebecause the calculation was simple; longer periods
used to smooth short term price swings, to get awere used because the movements in those days
better indication of the price trend. Let’stook time to take off and to complete. This tradition
have a look at different moving averages and howis still alive today in the sense that investors still
some of the lag, typical to an average, can bewatch these averages. That is the reason why prices
compensated.generally experience support and resistance at the
Averages are trend-following indicators. A movinglevel of these averages.
average of daily prices is the average price of aThe 50-day moving average gives direction to the
share over a chosen period, displayed day by day.medium-time period. The 200-day moving average is
For calculating the average, you have to choose aimportant for a look at the long-term trend. Around
time period. The choice of a time period is always athe 50- and the 200-day averages, you will almost
reflection upon, more or less lag in relation to pricealways notice some form of support or resistance. It
compared to a greater or smaller smoothing of theis therefore a good idea displaying the 50- and
price data. There are a lot of different averages200-day moving averages on your price chart. The
used. I will limit this overview to the common ones.20-day moving average is most useful as an
First let’s talk about the simple movinginclination indication for short term trend lines.
average that is calculated by adding all prices withinIf you are a trend following medium term trend
the chosen time period, divided by that time period.trader, you probably keep an eye on one or the
That way, each data value has the same weight inother average. Of course you like a smooth average
the average result. The simple average has the bestto stay in the trade as long as possible. Smooth
smoothing, but generally also the biggest lag aftermeans a longer time period. The disadvantage will be
price reversals.too much lag at the main turning points. So you could
An exponential moving average gives exponentiallymake use of a technique to limit as much as possible
more weight, based on a selected percentage, to thethe lagging nature of the average. The principles for
more recent prices in a range based on this formula:limiting the lag of an average were introduced by Dr.
EMA= (price * EMA %) + (previous EMA * (1Joe Sharp in Stocks & Commodities magazine,
– EMA %))January 2000. Using a 50-days zero-lagging simple
Most investors do not feel comfortable with anmoving average for example will clearly show much
expression related to percentage in the exponentialless lag compared to the 50-days standard simple
moving average; rather, they feel better using a timemoving average.
period.Another interesting average that can be used to
If you want know the percentage in which to worksmooth larger chunks of data without the
using a period, this formula gives you the conversion:disadvantage of a larger lag is the TEMA average or
EMA Percentage(%) = 2 / (Time period +1)Triple Exponential Moving Average. This average was
Compared to the simple moving average, theintroduced by Patrick Mulloy in Technical Analysis of
exponential moving average will therefore followStocks & Commodities magazine, February 1994.
closer the price evolution. This will result in lessAverages of 100 days and more will only show little
smoothing compared to the simple moving average.lag, while the smoothing will be quite good. TEMA is
A weighted moving average puts more weight onnot simply a triple exponential moving average, as
recent data and less weight on older data. Ayou probably would assume from the name. The
weighted moving average is calculated by multiplyingintention of TEMA is to limit the typical lag of an
each datum with a factor from dayaverage.
“1” till day “n” for theAn ‘n’ day exponential average (EMA)
oldest to the most recent data; the result is dividedhas a smoothing factor alpha of:
by the total of all multiplying factors. In a 20-dayAlpha = 2 / (n + 1) and a delay of:
weighted moving average, there is 20 times moreDelay = (n - 1) / 2. The larger the average period n,
weight for the price today in proportion to the pricethe better the smoothing, but, unfortunately, the
20 days ago. Likewise, the price of yesterday getslarger the delay. TEMA uses a technique of John
19 times more weight, and so on. The weightedWilder Tukey to compensate the delay. The data is
average follows the price movement the closest andsent several times through the same filter and
moves in general smoother than the exponentialcombined afterward:
average. Determining which of these averages to useTEMA = (3*EMA – 3*EMA(EMA)) +
depends on your objective. If you want a trendEMA(EMA(EMA))
indicator with better smoothing and only little reactionThe application of the TEMA average makes most
for short time movements, the simple average issense if you want to smooth larger data periods,
best. If you want a smoothing where you can stillwhereas the delay must remain as small as possible.
see and react to the short period swings, then eitherOf course you can start making all kinds of
the exponential or weighted moving average is thecombinations with the different averaging techniques,
better choice.combining simple, exponential or weighted moving
The 20-, 50-, and 200-days simple moving averagesaverages with the TEMA and zero-lagging average
were mostly used in the past before the advent oftechniques. That way you can create your own
personal computers. A simple average was usedaverage that fits best your way of trading.