Smoothing The Ride With Moving Averages by Edward Donie
There are many ways to smooth out fluctuations in the movement of prices. So what’s the best?
Because of the daily volatility of prices, investors use many methods to smooth out these fluctuations to analyze longer time frame trends in price movements. Two common methods are the simple moving average (Sma or MA) and the exponential moving average (Ema). Both are calculated for a variety of time frames. They can also be combined to create other indicators and signals. Which is better? We will examine two frequently used time frames, 20 days and 50 days.
SIMPLE MOVING AVERAGE
The simple moving average for a particular number of days is the sum of most recent closes for that number of days divided by those days. After the close of trading, it is updated to include today’s data and the data of the oldest day is dropped. This figure is plotted on charts to provide a smoother interpretation of the direction of prices. In the case of the 20-day simple moving average, it is calculated by adding the closing prices of the last 20 days and dividing that total by 20. The 50-day Sma is calculated by adding the closing prices of the last 50 days and dividing that total by 50.
EXPONENTIAL MOVING AVERAGE
The calculation of the exponential moving average is less intuitive. It is calculated by taking a percentage of yesterday’s exponential moving average and adding a percentage of today’s close. The two fractions must total 100%. The fractions for any number of days can be found in many references. Fortunately, most charting packages include the Ema in their sets of charting tools, so all you have to do is specify the number of days or parameters you prefer. The percentages for 20- and 50-day Emas are shown in Figure 1.