STOCK GOODIES PLAYS OF THE WEEK

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Exponential Moving Average (EMA)

EMA helps with the lag we get on Simple Moving Averages (SMA) by giving more weight to the more recent price information. The weight given to the most recent price will depend on the number of periods in the moving average. EMA is calculated using 3 steps:
1st - get the SMA by adding the closing prices over the specified period i.e. 5 SMA on a daily chart is the closing price each day over a 5 day period, divided by 5.
2nd - Calculate the weighting multiplier by dividing 2 by the time period 1 and multiplying that answer by 100 to get the percentage i.e. 5 EMA = 2/(5 1) = 0.3333 X 100 = 33.33%
3rd - Calculate the EMA using the % that applies to the time period you are using. Here is the formula:
EMA: {Close - EMA(previous day)} x multiplier EMA(previous day).

Your head may be hurting right now, don't worry most trading platforms will calculate the EMA for you. The important thing is that you remember that the lagging we get with SMA is counteracted with the EMA, giving us a stronger trend indicator.

For those of you who are math freaks like myself, below is an example of how to calculate EMA:
A 10-period exponential moving average applies an 18.18% weighting to the most recent price. A 10-period EMA can also be called an 18.18% EMA. A 20-period EMA applies a 9.52% weighing to the most recent price (2/(20 1) = .0952). Notice that the weighting for the shorter time period is more than the weighting for the longer time period. In fact, the weighting drops by half every time the moving average period doubles.

Below is a spreadsheet example of a 10-day simple moving average and a 10-day exponential moving average for Intel. Simple moving averages are straight forward and require little explanation. The 10-day average simply moves as new prices become available and old prices drop off. The exponential moving average starts with the simple moving average value (22.22) in the first calculation. After the first calculation, the normal formula takes over. Because an EMA begins with a simple moving average, its true value will not be realized until 20 or so periods later. In other words, the value on the excel spreadsheet may differ from the chart value because of the short look-back period. This spreadsheet only goes back 30 periods, which means the affect of the simple moving average has had 20 periods to dissipate.



Below is an example of a chart with both the SMA