In financial applications a simple moving average (SMA) is the unweighted mean of the previous n datum points. However, in science and engineering the mean is normally taken from an equal number of data on either side of a central value. This ensures that variations in the mean are aligned with the variations in the data rather than being shifted in time. An example of a simple unweighted running mean for a n-day sample of closing price is the mean of the previous n days' closing prices. If those prices are then the formula is
When calculating successive values, a new value comes into the sum and an old value drops out, meaning a full summation each time is unnecessary for this simple case,
The period selected depends on the type of movement of interest, such as short, intermediate, or long term. In financial terms moving average levels can be interpreted as support in a rising market, or resistance in a falling market.
If the data used are not centred around the mean, a simple moving average lags behind the latest datum point by half the sample width. An SMA can also be disproportionately influenced by old datum points dropping out or new data coming in. One characteristic of the SMA is that if the data have a periodic fluctuation, then applying an SMA of that period will eliminate that variation (the average always containing one complete cycle). But a perfectly regular cycle is rarely encountered.
For a number of applications it is advantageous to avoid the shifting induced by using only 'past' data. Hence a central moving average can be computed, using data equally spaced either side of the point in the series where the mean is calculated. This requires using an odd number of datum points in the sample window.
Read more about this topic: Moving Average
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