# Education: Moving Averages and Their Importance (Simple and Exponential) ### What are moving averages?

• Moving averages are one of the most useful methods of identifying and profiting from trends by the smoothing of price data
• Moving averages are one of the oldest tools in technical analysis and are used in many different types of capital markets such as stock, commodity and foreign exchange markets
• Moving averages are a lagging indicator

### Why do we use moving averages?

• Moving averages are used to smooth price (the longer the period, the smoother the moving average will appear)
• Moving averages help technicians determine trend and trend changes
• Moving averages are used to identify support and resistance levels
• Moving averages can also be used to identify increasing or decreasing price momentum
• Moving averages have become a very important tool due to the recent shift toward algorithmic trading

### The two most common types of moving averages

##### Simple moving average (SMA)
• Constructed by adding a set of data (closing prices) and then dividing by the number of observation in the period being examined

Calculation:

• Daily price close of a stock between March 10th and March 19th: 1,2,3,4,5,6,7,8,9,10,
• First data point of a 10-day simple moving average is calculated as follows: (1 + 2 + 3 + 4 + 5+ 6 + 7 + 8 + 9+ 10) / 10 = 5.5
##### Exponential Moving Average (EMA)
• Gives a higher weighting to recent prices unlike the simple moving average which gives each price equal weight, thus reduces lag time

Calculation:

• Simple moving average calculated above = 10-period sum / 10
• Current Weight: (2 / (# of days in the moving average + 1) ) = (2 / (10 + 1) ) = 0.1818 (18.18%)
• EMA = ((Current price – Previous EMA) × Current Weight) + Previous EMA

### Commonly used moving averages

##### 50-Day Moving Average
• The average closing price of a stock over the last 50 days
• Has been called the Swiss army knife of investing tools
• Used for determining the short to medium trend
• Often acts as the first major area of support in an uptrend or the first major area resistance in a downtrend
• Price generally remains above the 50-day moving average in a persistent uptrend as institutional investors favor buying at that level on price weakness
• The 50-day moving average appears as the 10-week moving average on weekly charts ##### 200-Day Moving Average
• The average closing price of a stock over the last 200 days
• Used for determining the overall trend
• If a stock is above an upward sloping 200-day moving average, the stock is considered to be in an uptrend
• If a stock is below the 200-day moving average, the stock is considered to be in a downtrend
• Recognized as a major support when price is above this moving average and resistance when price is below
• The 200-day moving average appears as the 40-week moving average on weekly charts ### Strategies for using moving averages

• Determining whether a stock is in an uptrend or downtrend
• Determining support or resistance
• Can be used as a trailing stop-loss order
• Used in the construction of many commonly used technical indicators such as the MACD and Bollinger Bands (to name only two of many)
• Giving Buy or Sell Signals (many technicians use the moving average cross as way to determine buy/sell signals)

### The Golden & Death Crosses

• The golden cross is a bullish technical indicator formed when the 50-day moving average crosses above the 200-day moving average suggesting a new uptrend has begun
• The death cross is a bearish technical indicator formed when the 50-day moving average crosses below the 200-day moving average suggesting a new downtrend has begun ### Final Thought

Moving averages are a very important tool and can be customized to each investors personal trading system, time-frame and strategy. When used properly it can be a very profitable endeavor. Have a great day! 🙂  