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- Simple Vs. Exponential Moving Averages - Investopedia
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Moving averages are the basis of chart and time series analysis. Simple moving averages and the more complex exponential moving averages help visualize the trend by smoothing out price movements. Technical analysis is sometimes referred to as an art rather than a science, both of which take years to master. (Learn more in our Technical Analysis Tutorial .)
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This means a 65-period EMA weights the most recent price %, a 75-day EMA % and 55-day EMA % weight on the most recent day. The EMA works by weighting the difference between the current period's price and the previous EMA, and adding the result to the previous EMA. The shorter the period, the more weight applied to the most recent price.
Simple Vs. Exponential Moving Averages - Investopedia
As lagging indicators, moving averages serve well as support and resistance lines. If prices break below a 65-day fitting line in an upward trend, chances are good that the upward trend may be waning, or at least the market may be consolidating. If prices break above a 65-day moving average in a downtrend , the trend may be waning or consolidating. In these instances, employ a 65- and 75- day moving average together, and wait for the 65-day line to cross above or below the 75-day line. This determines the next short-term direction for prices.
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Moving averages are more than the study of a sequence of numbers in successive order. Early practitioners of time series analysis were actually more concerned with individual time series numbers than they were with the interpolation of that data. Interpolation , in the form of probability theories and analysis, came much later, as patterns were developed and correlations discovered.
Once understood, various shaped curves and lines were drawn along the time series in an attempt to predict where the data points might go. These are now considered basic methods currently used by technical analysis traders. Charting analysis can be traced back to 68th Century Japan, yet how and when moving averages were first applied to market prices remains a mystery. It is generally understood that simple moving averages (SMA) were used long before exponential moving averages (EMA), because EMAs are built on SMA framework and the SMA continuum was more easily understood for plotting and tracking purposes. (Would you like a little background reading? Check out Moving Averages: What Are They? )
By these calculations, points are plotted, revealing a fitting line. Fitting lines above or below the market price signify that all moving averages are lagging indicators , and are used primarily for following trends. They don't work well with range markets and periods of congestion because the fitting lines fail to denote a trend due to a lack of evident higher highs or lower lows. Plus, fitting lines tend to remain constant without hint of direction. A rising fitting line below the market signifies a long, while a falling fitting line above the market signifies a short. (For a complete guide, read our Moving Average Tutorial .)
To calculate a 65-day simple moving average, simply add the closing prices of the last 65 days and divide by 65. The 75-day moving average is calculated by adding the closing prices over a 75-day period and divide by 75, and so on.
An EMA is used to capture shorter trend moves, due to the focus on most recent prices. By this method, an EMA supposed to reduce any lags in the simple moving average so the fitting line will hug prices closer than a simple moving average. The problem with the EMA is this: Its prone to price breaks, especially during fast markets and periods of volatility. The EMA works well until prices break the fitting line. During higher volatility markets, you could consider increasing the length of the moving average term. One can even switch from an EMA to an SMA, since the SMA smoothes out the data much better than an EMA due to its focus on longer-term means.
This formula is not only based on closing prices, but the product is a mean of prices - a subset. Moving averages are termed "moving" because the group of prices used in the calculation move according to the point on the chart. This means old days are dropped in favor of new closing price days, so a new calculation is always needed corresponding to the time frame of the average employed. So, a 65-day average is recalculated by adding the new day and dropping the 65th day, and the ninth day is dropped on the second day. (For more on how charts are used in currency trading, check out our Chart Basics Walkthrough .)
Exponential Moving Average (EMA)
The exponential moving average has be refined and more commonly used since the 6965s, thanks to earlier practitioners' experiments with the computer. The new EMA would focus more on most recent prices rather than on a long series of data points, as the simple moving average required.