Moving Average: Basics

Apurva Sheth
Moving Average is probably one of the most popular technical tools ever developed. Moving Averages are not only popular amongst technical analysts but they are also popular amongst wide section of the financial community. The tool is equally popular amongst traders, fundamental analysts and the financial media as well.

Moving Average is one of the simplest and arguably the least ambiguous methods to determine a trend. Simplest because even a high school student can calculate it. Earlier I showed you how most people draw trendlines in a wrong manner. A trendline drawn incorrectly will ultimately end up with wrong interpretations. But this is not the case with moving averages they are as mathematical and as objective as they can be and therefore the least ambiguous. Thus, if price is above its moving average then the trend is considered as up and vice versa. There can't be any ambiguity on this.

Moving averages are nothing more than the average price a stock traded for over a given period. But they're important psychological levels for many market participants. I am sure most of you already know this and probably even what I am going to tell you later today. You may not want to spend time on the basic stuff and move straight to advanced levels. Let me assure you that I will tell you all the advanced ways that I know to use a moving average. But before I do that I would like to lay a strong base that will act as a foundation for studying moving averages at an advance level.

You know that only a strong foundation can support a tall building. And spending some time to refresh the basics isn't that bad after all.

You may have seen one of those squiggly lines on a stock chart that normally chug along with the price. These are moving averages. There are many types of moving averages like simple, weighted, exponential, triangular, variable etc. The two most widely used moving averages out of them are simple moving average (SMA) and the exponential moving average (EMA).

A simple moving average is a calculated by totaling the closing prices of a select period and dividing the sum by the number of observations. The average obtained is the "central" value of a set of these closing prices.

For example a 5 day simple moving average is the 5 day sum of closing prices divided by 5.

Calculation of Simple Moving Average
Date Closing Price 5 Day Total 5 Day SMA
1-Jun 11
2-Jun 12
5-Jun 13
6-Jun 14
7-Jun 15 65 13
8-Jun 16 70 14
9-Jun 17 75 15
12-Jun 18 80 16
13-Jun 19 85 17
Source: Profithunter

In the above table we have calculated the 5 Day simple moving average for a set of closing prices. To calculate a 5 day moving average we will have to wait for data of 5 days to arrive once we have them we calculate the total of these 5 days and then divide it by 5. This gives us the figure of the moving average which is shown in the last column. So for 7th June we get a 5 day moving average value of 13.

As we move ahead and get the closing prices of 8th June we drop the earliest closing price (11) of 1st June from the calculation and consider only the latest 5 days closing price data. Thus old data is dropped as new data becomes available. This is what 'moves' the moving average along the time scale.

Prices gradually increase from 11 on 1st June to 19 on 13th June. The 5 day simple moving average also rises from 13 to 17 over a 5 day calculation period.

The exponential moving average is also calculated on similar lines to that of a simple moving average with only caveat being that most recent data is given higher weightage. Exponential moving averages became more popular after the advent of desktop computers as it involved complex calculations which was difficult to do by hand earlier.

Another reason why exponential moving averages became more popular is that more recent transaction prices are more influential on supply and demand levels today.

For our purposes knowing how a simple moving average is calculated is more than enough. The best way to use either of these moving averages is to activate both of them, just by clicking them on the chart, and then to select the one that best fits the data. Pick the one that acts more accurately as support or resistance for the stock.

As you might expect, the time period of a moving average has a lot to do with its usefulness. More on that in the next article.

Do you incorporate moving averages in your trading and investments? Share your views in the Club or share your comments here.

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10 Responses to "Moving Average: Basics"
Sanjay Bhisikar
16 Sep, 2016
hiLike 
HN CHOUDHARY
25 Sep, 2015
Excellent and easy conceptual explanations. Sure as you said one needs strong fundamentals in early years (in school ) to do well later. Further want to learn now advantages and use of shorter and longer period moving averages in trading. And how exponetial moving averages are calculated by giving an example. CHOU HN. Like 
Ramesh Rajpal
06 Jun, 2015
This is very good conceptual explanation. You have rightly said that the basics are more fundamental ina strong building I would also request you to explain advantages etc of shorter and longer period moving averages and where they can be used. And how exponetial moving averages are calculated by giving an example.Like 
dipak chandwani
14 May, 2015
Dear Apurva, Why are you giving detail of basic maths. Give some real magical or your experience with technical . this all are available in all technical book. I hope you understand me when we join your page we have high expectation from you Like (1)
ajit
09 May, 2015
Give an example of exponential moving average as well. How much wrightage is given is given to recent data ? Is it also fixed for any EMA ? Thanks for the clarity of article. Good reading!!Like 
M.Seshadri
09 May, 2015
Hi, this method is simpler and a good tip for the user. I would like view the exponential one. ThanxLike 
asok chatterjee
08 May, 2015
your write up on sma is excellent. kindly teach us ema too. and then how to find support and resistence levels for individual stocks on daily basis.Like (1)
prasad
07 May, 2015
Hi, definitely these kind of stuff will help many. Please release the new tips on a regular basis. And you could have explain exponential method also with a very simple logic...thanksLike 
s n keshari
06 May, 2015
this data ts very useful for the trading purpose. Thanks for sharing your knowledge.Like (1)
PANTAGANI
06 May, 2015
Dear Apurva Sir, As you said, it is easy so far in understanding the SMA. Excellent narration helps us a lot.Pl. continue the article for our sake.We will be benifitted very much by your simple and easy understanding language.Like 
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