Understand 5 Types Of Moving Average: The simple moving average is the basic moving average, in trading terms it is known as “SMA”.
It is an arithmetic moving average, the calculation of a simple moving average is quite simple, it is done by adding the closing price of the desired time period and dividing the number by the number of observations.
Trading in the stock market means analyzing a stock’s price and volume movement and taking trades on that information. This type of analysis is called technical analysis, and technical analysis is all about indicators of price and volume.
There are a lot of indicators that provide information regarding this. Today we are going to learn about moving averages and the types of moving averages.
What Are Moving Averages?
A moving average is a tool used in technical analysis. It is a price indicator. This moving average plots the data on a line that smooths out the price fluctuation in the candle chart.
This moving average line helps us determine the trend of the stock, allowing investors to determine whether to buy, sell, or hold the stock. “Trend is a friend,” traders often say.
The key determinant of any moving average is the time frame involved, so what are the time frames in moving averages?
Moving averages are customizable indicators. The trader has the option to choose the time frame that they want, and the moving average is calculated using that time frame.
They are described as 20MA, 50MA, and 200MA, which simply means that the chart’s time frame is for 20 periods, 50 periods, and 200 periods, respectively.
So, for example, 20 MA means we are calculating the moving average for the prices for 20 days. The shorter the span of the moving average, the more sensitive it is to the price.
A moving average is usually calculated on the closing price of the stock, but the trader can choose from a variety of choices to determine the basis. For example, it can be on the opening price, high price, low price, or many others.
The Importance Of Moving Averages
Moving averages are lagging indicators (a lagging indicator is an indicator of previous performance; it measures how it was performed; in this case, it is the price.) It helps us establish the stock’s support or resistance levels.
It serves as a basis for other indicators like MACD and Bollinger Bands. It is frequently used by most traders. It is simple and effective.
List of 5 Types Of Moving Averages
There are multiple types of moving averages. To simplify things, we have curated five relevant types of moving averages that every trader should know.
1. Simple Moving Average
Example- Here we will see a 15 SMA, here is the closing price of the stock.
(100+103+105+98+94+96+100+104+105+106+103+101+100+99+97) / 15
Therefore the moving average for this 15-day period is 107.47, A 15-day moving average would average out the closing price for the first 15 days. The next data would drop the first price or the earliest price and add the price of the 16th day.
The simple moving average is customizable for any time frame, the longer the time frame smoother the line, and the shorter the time frame more volatile the line. SMA is used for long-term investing and is a very useful tool.
Pro-tip; the bullish indicative pattern the “golden cross over” happens when a short-term SMA breaks the long-term SMA, with high price volumes.
2. Exponential Moving Average
The exponential moving average is a type of moving average that considers the most recent data point or price point. They are very reactive to new prices.
The problem with a simple moving average is that it gives equal weight to the old price and the new price, so it is not helpful for short-term trades.
Traders believe that recent price data is always better.
The exponential moving average is more sensitive to price movement turbulence than the simple moving average.
When the current market price is greater than the EMA, the outlook is bullish. The trend is bearish if the current market price is lower than the EMA.
ALSO READ: Most Effective Top 5 Bullish Indicators!
3. Weighted Moving Average
A weighted moving average allots more weight to the current price since it is more relevant than the previous price data. The sum of the weightage should add up to 1, or 100 percent.
It is actually a mixture of both simple and exponential moving averages.
The calculation of the weighted moving average is determined by the time frame selected for the indicator.
Example- 5 period WMA is calculated
WMA = (P1 * 5) + (P2 * 4) + (P3 * 3) + (P4 * 2) + (P5 * 1) / (5 + 4+ 3 + 2 + 1)
Here P1 is the current price and P2, P3, P4, and P5 are the previous prices of the asset.
The red line is the weighted moving average, and the dark green line is the simple moving average. We can notice that there is a gap between the red and the green line. That is due to the higher weights given to the newer prices.
4. Double Exponential Moving Average
The double exponential moving average (DEMA) uses two exponential moving averages to eliminate the price lag that is caused by previous price points.
When the price crosses the moving average, that might signal a trend. This is just like an exponential moving average, but the difference is that the first EMA is multiplied by 2 and the smoothed-out EMA is subtracted.
DEMA= 2 EMA (previous period) – EMA of EMA(previous period).
DEMA’s react quicker than other moving averages since there is no lag in the price data. DEMA is used by day traders and swing traders mostly.
Traders can use two DEMA’s like 20 DEMA and 50 DEMA. Using two signals can be an indicator when two lines cross.
The black line represents the simple moving average and the red line represents the DEMA. As we can see, the red line is more reactive and smoother.
5. Time Series Moving Average
Time series moving average or time series forecast (TSF) is a linear regression calculation that plots each bar’s current regression value using the least square method.
The general formula to calculate the time series moving average is Y=MX+C. Instead of plotting a straight line, we can use this indicator. This uses a specific period of the time frame.
Like all the moving averages mentioned, this one is also very reactive to prices.
Whenever the indicator rises above the price, there is a bullish trend. Whenever the indicator goes below the price, there is a bearish trend.
Moving averages is a tool that indicates the trend of the security by smoothing out the price data, it is a very useful tool that is used by most traders.
The most prominent types of moving averages are simple moving averages which are used for long-term trend recognition. EMA and DEMA are similar and they both consider new price points.
The weighted moving average is a combination of both SMA and EMA. Moving average is an excellent price indicator.
Tags: How does a Moving average work, Moving Average, Moving average formula, Moving Average Indicator, Moving average method, Simple moving average, Types of Moving Averages for Effective Trading, What are the 2 moving averages?, What are the three moving averages?, What Is A Moving Average, What Is A Moving Average And Its Example, Which moving average is best?, Types Of Moving Average Every Trader Should Know, types of moving average, types of moving averages, moving average types, double moving average example, dema vs ema