Stocks & Commodities V. 25:2 (20-26): Anticipating Moving Average Crossovers by Dimitris Tsokakis

Stocks & Commodities V. 25:2 (20-26): Anticipating Moving Average Crossovers by Dimitris Tsokakis

Although simple moving averages may be a technical analyst’s best friend, they do tend to lag. Here’s how you can overcome this problem.

Moving averages are excellent indicators to confirm existing trends in spite of their lag. To overcome this lag, several alternatives such as the exponential moving average (EMA) and the weighted moving average (WMA) have been applied to price charts. In this article, I will not tweak the simple moving average (SMA). Instead, I will decrease the lag of the SMA crossover by one day by basing it on a simple mathematical observation.

SIMPLE MOVING AVERAGE CROSSOVER

First, I would like to show you an arithmetic example. A five-day simple moving average (MA5) is the average of the last five closing values:

MA5 = (C + C-1 + C-2 + C-3 + C-4)/5 = C/5 + (C-1 + C-2 + C-3 + C-4)/5 [A1]

In a similar fashion, a four-day SMA is:

MA4 = (C + C-1 + C-2 + C-3)/4

Its previous value is:

MA4-1= (C-1 + C –2 + C –3 + C –4)/4

or 4*MA4-1= C-1 + C –2 + C –3 + C –4

or 4* MA4-1/5=( C-1+C –2+C –3+C –4)/5

If you replace (C-1 + C-2 + C-3 + C-4)/5 in [A1] you get:

MA5 = C/5 +4*MA4-1/5 or MA5=(C+4*MA4-1)/5 [A2]