V.10:8 (354-357): Understanding Exponential Moving Averages by Raymond Rothschild

Understanding Exponential Moving Averages by Raymond Rothschild

Do you ever find yourself thinking that maybe you ought to try using the exponential moving average but find yourself intimidated into paralysis? Don't be. Let Raymond Rothschild be your guide into a not-so-alarming technique.

Moving averages in general have been extensively analyzed by many investigators—all except the exponential moving average. The objective in technical analysis is to use every tool available, and that includes exponential moving averages. But first to review the formula for the simple moving average: in an n-day simple moving average, the prices of the previous n days are added and the sum is divided by n. For example, if n were equal to 10, we would add the prices of the prior 10 days and then divide this value by 10 to obtain the moving average for the current day. As we continue along to successive days, it is not really necessary to always add n days of data. All we really have to do is drop off the first day's price, add the current day's price to our sum and then divide by n.

That is the simple moving average. Other forms exist, one of which is the exponentially smoothed moving average. This particular moving average has a recursive form that makes it easier to use than the simple moving average. The recursive form refers to the fact that the exponential average for the current day is determined by the value of the previous day, defined thus:

...