What Is Moving Averages In Trading?

The term moving average is often used in trading particularly in technical analysis of the market. Moving average represents an indicator that is employed to refer to the average closing price of a particular market over a specified duration.

Traders employ this technique of moving averages to identify the then current market momentum.

Moving averages are broadly categorized into two; simple moving averages (SMA) and Exponential moving average (EMA).

In simple terms, SMA is the average of all the data points in the series divided by the number of points while EMA is a type of moving average that places a greater weight and significance on the most recent data points.

A major difference between the two moving averages is that the simple moving average does not give any weighting to the averages in the data set but the exponential moving average gives more weighting to current prices.

How to Calculate Moving Averages

Simple Moving Average:

SMA =

Where:

A= Is each of the data points

n = Number of time periods

For example, looking at a 5-day SMA on a daily chart of EUR/USD and the closing prices over the 5 days are as follows:

Day 1: 1.321

Day 2: 1.301

Day 3: 1.325

Day 4: 1.327

Day 5: 1.326

SMA = (1.321 + 1.301 + 1.325 + 1.327 + 1.326)/5

SMA = 6.6/5

SMA = 1.32

Exponential Moving Average:

EMA =

Where:

EMAt​= EMA today

Vt​= Value today

EMAt​ = EMA today

s =smoothing

d = number of days​

Steps for calculating EMA:

1. Calculate the SMA for the particular time period

2. Calculate the multiplier for weighting the EMA using the formula:

[2 ÷ (selected time period + 1)]. So, for a 10-day moving average, the multiplier would be [2/(10+1)]= 0.01818.

3. Use the smoothing factor combined with the previous EMA to arrive at the current value.

For example, looking at a 10-day EMA for a share, the table below displays how the EMA would be calculated: