One of the best things about the internet is that it makes information easily accessible. So without any inhibitions, anyone can learn about anything. Take the trading domain for example – there was a time when there were a very few people who found the time to trade. The market behavior on the whole was different back then. With online trading catching up, more people found trading to be a great place to park their spare funds. If you are new to trading you must have heard about the need for the use of technical analysis to make decisions. Among the many technical strategies used moving averages are very popular.
What are moving averages?
When we talk statistics, computation of the averages is often considered one of the easiest way to sample a lot. Moving averages are used to understand the price and the value of a chosen stock based on the calculation of the average price over a particular period of time.
Simple moving average SMA-
This is where you take the price of the stock at the session closing time in a given period. The average calculation would be similar to the usual calculation – the sum of the prices divided by the number of instances chosen.
Exponential moving average EMA-
This one takes the simple moving average one step higher as it also assigns a weight to the values and gives a more relevant result. To being with you would calculate the recent SMA. Along with this, you would need the weight coefficient.
Weight coefficient = 2/ (time period + 1)
The time period is the same time period over which the SMA was calculated. Once the weight coefficient and the SMA are available, EMA is calculated in the following way-
EMA = (closing value – SMA) * weight coefficient + SMA
The EMA might be slightly more complicated than the SMA. But you would ideally be using a longer time period in this case and a larger chunk of the historical data would be used here. Historic data here means the recent history right up to the previous closing value.
Given that the EMA takes into account the most recent data and then adds a weight to it, it would be a more reliable result which can be extrapolated to find the value of the stock at any point of time.
Why are moving averages so popular?
Moving averages are among the easiest of technical indicators in the market. There are multiple sources where you would find online tools to help you with the calculation part. So you can easily expand the dataset in order to get a clear picture.
Both SMA and EMA are useful in more than just the stock market.
By extending the data you would be able to compute multiple results. This would also be a great way to understand the consistency in patterns if any.
The real benefits of moving averages can be felt if you combine both SMA and EMA to make your trading decisions.