Technical Analysis
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Averages.
An average is a smoothening of the edges in a price movement. The market will always fluctuate up and down and will rarely rise and fall vertically. Normally it moves up and down in waves. The counter moves are often very volatile and makes the understanding of a trend bit difficult. The smoothening of the prices by way of averages helps to gauge the underlying trend.
There are three types of averages.
Simple Moving Average
Weighted Moving Average
Exponential Moving Average
Simple Moving Average (sma)
The calculation of a simple moving average first we have to decide the number of days for which a moving average is to be calculated.
Suppose for a 3 days moving average, then the closing price of 3 days is totaled and divided by the same number of days. The answer derived is the first reading of the moving average.
We then do not consider the reading for the first day and add the reading for the forth day and repeat the process of dividing it by the number of reading. This will be the second reading of the moving average.
This process deletion and addition is repeated till the end. The prices which are derived after this whole process are then plotted along with the bar chart in a line format and one can know the under lying trend much easily then monitoring the actual price movement.
The more the number of days selected for this process the more smoothening of the edges. But one has to keep in mind that more the number of days the later the signal generated.
Day Closing Price 3 days m.a. 5 days m.a.
1.1.00 250
3.1.00 262
4.1.00 268 (250+262+268)/3 =260
5.1.00 275 (262+268+275)/3 =268
6.1.00 280 (268+275+280)/3 =270 267
7.1.00 289 (275+280+289)/3 =281 275
10.1.00 302 (280+289+302)/3 =290 283
Note that the difference between the 3 days sma and the 5 days sma in the above table from 5-1- 2000 onwards. There will always the difference between the two averages unless the trend reverses and closing price moves down.
Weighted Moving Average (wma).
In weighted moving average each reading is given a specific weight and then multiplied by the reading. This will be termed as weighted close. The weighted close is then summed and divided by the sum of weight. The product derived is called the weighted average.
Then the first reading is omitted from the calculation and one more reading is considered for the purpose of calculation and the process is repeated.
Day Closing Price Weight Weighted Close Weighted Close
1.1.00 250 1 250
3.1.00 262 2 524
4.1.00 268 3 804
3 days weighted close total = 250+524+804 = 519
Sum of weight = 1+2+3 =6
Average = 519/3 = 173.11
Exponential Moving Average (ema).
The exponential moving average is derived as follows.
Current closing-previous EMA) x factor + previous exponential average, where factor is =2/n+1. The n stands for the number of days for which the average is to be calculated.
Day Closing Price 5-day exponential average.
1.1.00 250 250
3.1.00 262 254
4.1.00 268 258.6
5.1.00 275 264
6.1.00 280 269.3
7.1.00 289 275.8
10.1.00 302 284.4
The closing price of the first day is taken as the average for that day. The actual 5 days exponential moving average can be derived from the sixth day onwards and so on.
The factor calculation is as follows = 2/(n+1) where n is number of days (5)
i.e. 2/(5+1) = 2/6 = 1/3 0.33
Average on 3.01.00 will be as follows
Average = (current price – previous days average) x factor + previous days average
= (262 – 250) x .33 + 250 = 254
The moving average is a process of defining the underlying trend. For calculation of the moving average the number of days taken into consideration is the main criteria. This is done taking in view the type of a trend one wishes to track i.e. long term, medium term or a short term. For long term purpose 200 days moving average is the general norm. For medium term purpose