What is a moving average, and how do you use it?

Telegraph

01-07-2025

Moving averages seek to cut through the noise of wild swings in the stock market to provide a clearer picture of what is driving prices.
Through the application of moving averages you can use the same techniques market professionals apply to establish whether the current price is looking expensive or cheap relative to the trend they have identified, and then profit from its future response.
Here, Telegraph Money explains what a moving average is, and the strategies to use it.
What is a moving average?
Formula
Moving average in stock trading
Strategies using moving average
Reasons to beware of the moving average
What is a moving average?
The moving average is a simple mathematical calculation that uses the mean of the closing price of any asset over a given period of time. Because it simply uses price and time periods, it can be applied to any market, from share prices, foreign currency, and commodities like oil and gold. So, for example, to use a five-day moving average you take the closing price of an asset from five consecutive days, add all these together, and then divide by the number of periods, five in this case, to calculate the first point on your chart.
The average is moving because as you add every subsequent day's trading into the calculation the first price drops out from the total and you still divide by five, thus it 'moves'. It is considered a trend-following tool because it is always looking at past or lagging data.
Formula
The moving average calculation works as below, where 'P' refers to the closing price. The length of time can be whatever you like, but we've used five days:
Five-day moving average = P1+P2+P3+P4+P5 / 5
Exponential Moving Average
The exponential moving average works in a similar way, but it adds more weight to the most recent price movements, so the average reacts faster to changes in the market, and so it can allow you to identify changes in the trend more quickly.
To calculate the exponential moving average you start with the same simple moving average calculation and then work out the weighted multiplier.
Five-day moving average = P1+P2+P3+P4+P5 / 5
Weighted multiplier: 2 / (selected time period, in this case 5 + 1)
In this example, this comes to 0.3333 or 33.33pc.
Then add it all together to establish the exponential moving average.
Exponential Moving Average (EMA) = Price (p) x M + EMA (y) x 1 – M
In this case, p = closing price today, M = weighted multiplier and EMA (y) = EMA yesterday
In our example of a five-day exponential moving average we can see it would apply a weighting of a third to the most recent closing price, and the other two thirds to the previous four days, as opposed to the simple moving average which weights each closing price a fifth.
Moving average in stock trading
Because you are creating an average rather than following the daily price, it smooths out the wild swings you can sometimes get in the market.
Say, for example, there is somebody in the market who is forced to sell their entire holding in one day. The price of that asset on that day would fall sharply, but by looking at the moving average you would see it as an upward trend, and as an isolated event, so you could then buy on this weakness.
The most commonly used averages are the 50-day, 100-day and 200-day moving averages. They work because by filtering out the daily market noise, it shows a clear trend in either a rising bull market or falling bear market.