Moving Average - Overview, Types and Examples Moving Average - Overview, Types and Examples

# Moving Average - Overview, Types and Examples

Technical Indicators
10 Jul, 2024

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Stock trading is often categorised as a short-term assessment of the market. Traders use various technical analysis tools to make sense of market movements and take advantage of volatility. Moving averages are one of the most commonly used technical indicators by traders to understand stock prices and make suitable trading decisions. So what is a moving average, and why is it so important? Learn all about this indicator in this blog and refine your trading skills.

## What is a Moving Average (MA)?

A moving average is a popular technical indicator used to smooth out the price data and helps traders identify trends and suitable entry/exit points for successful trades. It calculates the average price of the asset over a set period (like days or weeks) providing traders with a clearer view of the market direction. This lagging indicator is effective in trending markets rather than a range-bound market where the prices are more or less stable.

## Types of Moving Averages

Traders can use different types of moving averages to better analyse the market. Here are the popular types of moving averages that traders often use while shaping their trading portfolios.

• ### Simple Moving Average (SMA)

This is the most basic type of moving average. It is calculated by summing up the closing prices of an asset over a specific number of periods and then dividing the total by the number of periods. This average is plotted on a chart to smooth out price data, helping traders identify the overall trend direction.

The formula to calculate a simple moving average is,

Simple Moving Average = (P1+P2+P3+.... Pn) / n

Where,

P = price of the asset for each period

n = number of periods

• ### Weighted Moving Average (WMA)

Weighted Moving Average(WMA) assigns different weights to various prices in the selected time frame. The WMA is a more responsive indicator than the SMA and provides better insights for traders.

The formula to calculate the weighted moving average is,

WMA = (W1xP1 + W2xP2 + W3xP3 +W4xP4 + .….WnxPn) / (W1+W2+W3+W4+... Wn)

Where,

P1, P2, P3, … Pn = The prices over the selected period.

W1+W2+W3+W4+... Wn = The weights assigned to the respective prices.

• ### Exponential Moving Average (EMA)

An exponential moving average provides a deeper analysis of the indicator by assigning weights to recent prices. This makes it more responsive to new information than the SMA. Therefore, the exponential moving average is particularly beneficial for traders aiming to seize short-term price shifts and swiftly adapt to emerging trends.

The formula to calculate EMA is,

EMA = Pt * [2/ (n+1)] + EMA (previous) * 1 - [2/ (n+1)]

where,

Pt = The current price or the price at the time ‘t’

n = number of periods

EMA (previous) = previous period’s EMA

• ### Double Exponential Moving Average (DEMA)

This is the advanced or refined form of market analysis using moving averages. The double exponential moving average (DEMA) is designed to reduce the time lag found in traditional moving averages. DEMA combines a single EMA with an EMA of the EMA, providing a smoother and more responsive indicator. This makes it far more responsive to price changes than simple moving averages and exponential moving averages.

The Formula for DEMA is,

DEMA = 2 * EMA1 – EMA2

## Example of Moving Average

Here's an example with stock prices to calculate the 5-day Simple Moving Average (SMA):

Collect the closing prices for 5 days:

Day 1: ₹250

Day 2: ₹240

Day 3: ₹245

Day 4: ₹230

Day 5: ₹235

250+240+245+230+235=1200

Divide by the number of days (5): 1200/5  = 240

The 5-day SMA is ₹240.

## Difference between Exponential Moving Average vs. Simple Moving Average

The key differences between the Exponential Moving Average and Simple Moving Average are highlighted below.

## Conclusion

Moving averages are a fundamental tool for traders. They are an excellent means to identify trends and pinpoint potential entry and exit points for profitable trades. Understanding the calculation and the differences between various moving averages helps traders focus on the nuances of the moving average indicator, enabling a better choice based on individual trading goals and risk tolerance.

##### Recent Blogs

The four types of moving averages commonly used by traders in India are the Simple Moving Average (SMA), Exponential Moving Average (EMA), Weighted Moving Average (WMA), and Double Exponential Moving Average (DEMA).

The basic calculation of the moving average involves adding up the closing prices of an asset over a specified number of periods and then dividing the total by the number of periods.

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