What is a Moving Average?
Moving averages, also known as rolling averages or running averages, are a way of examining an asset’s price action while ignoring short term noise. They let an investor look at the general direction of an asset’s price, smoothing away irregular swings in day to day trading.
Moving averages are calculated by averaging the daily asset price of over a given number of days (commonly 50, 100, or 200).
The easiest of these to calculate is the Simple Moving Average, or SMA. This is done by taking the closing prices of an asset over a given number of days, adding them together, and then dividing them by the number of days.
A simple moving average (SMA) technical indicator. SMAs are reactionary indicators, meaning that they do not predict future price movements.
Moving averages are used in analytics to quickly identify if an asset is in an uptrend or downtrend. Multiple moving averages for a single asset can be used in order to make predictions as to whether the asset will rise or fall in the future; for example, if the 30 day moving average of an asset is lower than the 15 day moving average, then the asset is likely to be in an uptrend.
The shorter the moving average, the more sensitive it will be to daily price action and short term noise; however, the longer the moving average is the less it will react to short term changes, even if they are significant – this is known generally as ‘lag’.
Typically, the short-term moving average ranges from 5 to 25 days, an intermediate term from 25 to 100 and a long term from 100 to 250 days.
All moving averages change with every day that passes, as a new average must be calculated including today’s closing price and excluding the previous initial price.
How moving averages work?
For example, say we have the following closing prices for an asset over 5 days:
(£12 + £14 + £16 + £13 + £14)/5 = £13.8
We now have a 5 day moving average of £13.8
The next day the asset has a closing price of £17. This must be included in the new calculation and the £12 closing price recorded 6 days ago must be excluded, like so:
£12 + £14 + £16 + £13 + £14 + £17 = £14.8
These constantly updated values are commonly charted on a graph to display the historical behaviour of the asset being assessed.
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Category: Financial Glossary