Simple vs Exponential Moving Average | Cameron May 9-16-19 | Getting Started with Technical Analysis
Good. Morning. Welcome back everyone my name is Cameron mance 11 o'clock Eastern Standard Time on a Monday morning that, means it's time to get back into our ongoing series, of discussions, called getting started with technical, analysis, and today. We're revisiting the, topic of trend identification. But taking a little bit of a different look at things in an earlier discussion we reviewed, how, moving. Averages, might be used by traders and Chartists, to identify trends on a chart but today we're going to explore the two different types of moving averages the pros and cons of exponential. Moving averages, versus simple moving averages so I'm looking forward to it hello, all of your returning veterans thanks for joining us week after, week I already see michelle steve nick paul tom and brittany chiming, in great, to have you back thanks for your continued, attendance, and your contributions. If. You happen to be here for the very first time I want to welcome you as well we budget up to 30 minutes for today's discussion, we may or may not use that full amount but. I also want to say hello to all of you listening in on the YouTube archives after the fact if you want to join us live for. The live. Webcast, you, can just put it in your calendar join us 11 o'clock Eastern, on Monday morning so all right now, as we dive in here a one, more quick reminder, if you're not following me on Twitter you. Can find, my handle at CMA underscore. TDA I love, that platform. The interaction. That we can have there so follow. Me there hello there Dave and Anthony, good morning. But. Here's what we're gonna do today we're gonna take just a moment to consider the risks associated with investing then we're gonna set as a precise, agenda, and they get right to that discussion, of simple moving averages, versus exponential, so here's. Some quick information that we need to remember. Any. Investment, decision you make in your self-directed account, is solely your responsibility past. Performance, of any security or strategies not guarantee future results for, success all, investing. Involves risks including risk of loss while this webcast, discusses, technical, analysis other, approaches, including fundamental, analysis may assert very different, views and finally. For those of you whose technical, analysis free options there's an overview of your options Greeks all. Right so let's go set the agenda three items on the agenda, first. Of all we're going to talk about the construction of simple. Moving averages, and the next bench moving averages and we're gonna explore the differences, the pros and the cons between, the two simple, moving averages versus exponential and then, we're gonna work on the application, so, I think that once we've done that it's. The looked at one or two or three stocks. As examples. Then, that helps to. Cement. The, learning what I want you to walk away with though is when, you are looking at an exponential, versus a simple moving average you know how to make the decision between you, know which one you might want to choose for, your own investing if you're, using moving averages in your in your technical, training all.
Right So let's talk about it first of all simple moving average this is something that we discussed, back. In Lesson, four when, I did a series of eight lessons and getting started with technical, analysis, trend identification. Was the topic if you want to look for that in our archives, but. I'm gonna quickly revisit that in a little bit more detail, and we're gonna use Home Depot, as our example here so. This should now be familiar I'm going to pop up here to our chart settings and let's, add a, simple. Movie empanada chart settings apologize. The, Edit Studies, icon. It's. The one that looks like a little beaker I'm gonna click on that and we're. Gonna type in the word simple, because we're gonna be adding a simple moving average select, that from our menu add, selected. And I'm going to customize this, moving average we're. Gonna click on the little gear, a couple. Of things that I'm gonna do to this I'm, gonna make it a longer. Term moving average how about we make it a. 20-period. Moving average and I'm. Gonna make it a thicker line, so that everybody can follow along. On. The webcast all, right so let's click OK and. Click. Apply. And. Just to revisit the concept here, what we're seeing is a, technical. Indicator that sometimes, used by chart, users, to. Get, a maybe, a clearer. View of what the current trend of a stock might be now what I'm using here is a 20-period. Moving average that's, about four weeks of data and so. This might be kind of a shorter term indicator, but, we might see this as it's, rising, and falling an indication of short-term, trend strength or weakness so. How is this constructed. Alright, so the simple moving average equation. How's. That calculated, very. Simple and just, as the name applies it, is simply an, average. Of prices, over whatever time frame we selected, and specifically, its closing prices, so. You'll notice our current. Moving average, value. Is right there around. $225, what, that's telling us is that over the last 20, days, the. Average closing price for, Home Depot has. Been. $225. And 16 cents now that includes, the. Current price today. So. The way this is calculated, is that, we take the, closing, price. Of. Day. One that's going back 20, days in this case. And. Then. We add that to the closing price of day two and, we add that to closing price of day three, and so. On and. We get it we, get a total, of all the average of all the closing prices over, the time frame selected, and then we just divide that by. The number of days. Selected. So that would be again, 20 days here, all. Right so that's how this number is generated and then, it's the changing. Value, of that. Of. That moving, average value, that, might give an indication to a technical, trader the, current direction of the trend so. Some. Potential. Applications. Here are determined, trend but also entry. And exit signals. So. That's a simple moving average, well. Who here has heard of an exponential. Moving average, but you wanted so what's the difference and which ones quote unquote better. Write. An exponential. Moving average, addresses. An issue, that, some investors are, confronted, with okay and actually Home Depot is a good example of exactly this issue that they run into look. At what this moving average is doing right now it's moving higher and higher and higher but, what a price is doing as of, this moment. Prices. Are dropping. This. Indicator, is not considered, to be a terribly, sensitive. Indicator. Because. What's, happening today is, no, more or, it's important, than, any closing. Price over, the timeframe. Of the moving average so in that case again it's a 20-period. Moving average, what's. Happening today is weighted, equally, with. Each of the closing values of the last 20 days. So. For some technical, traders that's just not sensitive enough I'm not saying all technical traders but for some they might be looking at this chart and essentially, screaming, in their minds hey, chart the, stock is falling but. My indicator, is not, reacting. Or. It doesn't appear to be and. They. Might be asking themselves so you are you seriously telling me that, what happened 20. Trading, days ago that's a month ago in calendar. Days is just. As, important, as what's, happening today and to. Some traders that may not make sense they, may want to emphasize what's happening today over. What, happened 20 days ago so the the adjustment, that's been made at. Least conceptually, is an, exponential. Moving average. So. What is an exponential, moving average will the name. Springs from the fact that today, is. Exponentially. More, important, to, this indicator, than what happened on day. One, so. The way that this is calculated. Is we, actually just take I'm gonna take this original, equation because, it's very similar.
Copy. That and, paste. It down, here so. We, do take the closing price of day one but. We multiply, that by, a. Factor of one and, then. We take the closing price of day two and, we multiply that by two, and, so, on so, we take day three. And. We multiply that by three. And. So. What's the net effect well by the time you get to today. This. Being a 20, day moving average, we, would take today's value, and right, at this moment the value is 230. $1.48. Multiply. That by 20. And, then. Add that into the equation so. What's happening today for, a 20 period, average is 20. Times more. Important, to the construction of the indicator as what, happened on day one so. Yeah we're waiting what's, happening right now much, more heavily so, what impact does, that have now whether you follow the math or not and we could work this out if you want to you could just just. Go, to the archive and run. Through how this would work okay so day one we take the closing value multiply that by one and then we add that today to accept. We multiply that day to value, by two and, so on and then, divide it all up it's actually not oh let me finish this. It's, not the number of days here. This. Would actually be the number of days. Times. All, of these closing, values. So. In. This case it would be. Divided. By. The. Numbers and how am I going to express that that, just occurred to me. In. Any way how. Do we want to phrase that what's the denominator. Gonna, be here, it's. The number of. Waited. Days. So. We have one here and two there and three there and so on we add those all up okay. All. Right but if you want to run through that calculation on, your own after the fact you can do that I don't want to spend too much time on the calculation, but I want to explore, the. The. Potential pros and cons, so. If, you can envision before, we even put on this exponential, moving average. What. Is it going to look like compared. To the original. Well. If one, day is weighted, above, the others even to some extent it's not weighted very much over yesterday. But it's weighted very, much more heavily than day one it. Creates, a greater, sensitivity, to, current, day movements. So. If we get a big move down today the, exponential. Moving average will reflect that a little bit more dramatically, than the simple, moving average so, what we wind up with is a line that's more jagged, in its presentation, it's, a little bit more. It's. Just more volatile, so. Let's add that to the chart let's pop up here to our little beaker icon and. I'm, gonna type in though I'm gonna start typing in the word exponential. I don't have to type the whole thing in it'll quickly find it there's, our moving. Average exponential, I'm, going to add that and make, sure that the timeframe, is the same for comparison, purposes, let's, keep the simple and the exponential, the same so, I'm going to come over here to our gear icon. And. I'm gonna change our timeframe to a 20, the default on mine happens to be 26, that's okay we're gonna change it to 20 let's. Make the width this same, but. I'm going to keep the color different, so that we can distinguish, between the two the simple moving averages of the green the, exponential, moving average, is the red click, OK click apply. And, then. Click OK again and we'll see now we, have what, appears to be quite, a similar. Line. But. By. Degree, there is some, difference, it's, still a trend line it. Still can conceptually, be used for a trend identification, but also potentially, for entry signals so, what an tree and exit signals let's. Talk about that for just a moment and this is where. It's. The. Real conceptual, difference between the two starts to become more obvious, let's. Suppose that a trader has a very simple, approach. They, get in when, price rises, above their moving average and they get out well, how, about rises, above and closes above and.
They. Get out when, the. Price falls below, and closes, below that, moving average. So. Let's look at some examples, here maybe we'll just come to this. Triumph this timeframe back here and actually even just rising, above might even be a better example of how you can get. Disparities. Between the two in this, case you'll. Notice right here on. June. 4th. We. Have the. The. Green Line but. Pardon me the, price. Rising, up and through, both. The green and the, red so, this a good illustration of how sometimes the, distinction is fairly minor, between. These two. Right. So there's an entry signal but. As we move ahead to you. Know it actually I have another stock that'll be a little bit more pronounced. Right. Here. This, is interesting, here. The the, red, exponential. Line which is more jagged it's more volatile. It. Has reached down toward, current price a little more a. Little. More closely and. Then. As price is rising, a trader, who's looking for an entry just. As price pops up above that moving average and if i zoom in on this maybe a little bit be a little bit easier for you to see. You. Can see the price did rise above, that, exponential. Moving average, on this day so. If someone were getting in on that evidence, that, would be an earlier. Entry, signal by a full day versus. The. Signal on the simple. Moving average which may have come the next day we're still solidly below that, simple moving average, so. Even. Though there appears, to be a comparatively, subtle, difference between these two and on, a day-by-day basis. It may not amount to much there, can be a significant. Difference on entry. Signals and also on exit. Signals, so. Then the question becomes is that. Difference. Does that make it a better signal. Well. That. One is that that's a tougher question to answer. Because. This faster, sound like it's better if. We. Have a faster. Moving average. Generating. Faster. Entry and faster, exit signals which is what an exponential, moving average, is designed to do does, that make it a better signal, not necessarily, right, for some investors they, are looking for speed, of entry and speed of exit however. The, the the. Trade-off there is that they may get more of what we call whipsaw. Events, you. Veterans, if you want to just chime in here it can be real trades or it can be just paper. Trades but, if any of you ever been into. A trade too soon you. Got in because you thought oh this looks good and then the very next it reverses and you think oops yeah, that was a little bit early or. On, the, back end of the trade you, get out a little bit too soon, stock, starts to move down it looks like time to get out so we pull the plug and then. The stock starts to rally again the next day so speed. Of entry speed of exit. Can. Have. A little bit break that a little, bit of a breakdown from time to time we call that a whipsaw. Where you're kind of whipped around in the trade. However, there, are other times where getting, in earlier proved to allow you to take more of an upside. Getting. Out earlier, allowed. Allows. The trader maybe in some cases to avoid more of the downside, so. Yeah, there, can be pros, and, cons I'm not here to tell you which. Is better than the other I can tell you though that, if a trader is more inclined, toward speed of entry speed of exit the exponential, is going to be the one that they are likely choose if. Though they prefer to be a little bit more patient, and maybe.
They're Willing to surrender some of the upside potential. Absorb. A little bit more of the downside risk on some trades in. An effort to avoid a, few. More whipsaw, events, premature. Entries premature, exits then, maybe that simple. Moving average might, be the better choice for that traitor let's, look at another example okay, so we're starting to weigh the pros and the cons we're doing this comparison, simple, moving average versus exponential, moving average let's. Look at one let's look at a stock where this gets more pronounced and the. Way that we can make this more pronounced, in. Another way actually, let's stick with Home Depot for just a moment. Generally. Speaking the. Longer, the time frame of the moving average the more pronounced the difference between the two can become so I'm going to come back up here and let's, edit those studies and what if instead of looking at 20-period. Moving average --is let's. Edit these and change, them to 50. I'm. Going to click OK on that one let's. Edit this one. Change. That to a 50. And. Click OK there we'll click apply click OK. Again and now. If i zoom back out. Using. My little uh. Magnifying. Glass icon, now, we can see it's, a little bit clearer, how that red line is a, little bit more, volatile. It's, wavier, as compared. To the green line this one's smoother. Right but, we can also see as that. More pronounced volatility, shows up it might get us out of trades a little bit sooner and, as. It goes down to the downside it might get us into, trades sooner, so, here's an example where, if, we're looking for a crossover. As an. Entry a price crossover, above a moving average line the. The. Exponential. Moving average, gave. An, entry signal boy. At least a couple of days before. The simple moving average. So. Good, example, there. But. Let's look at a different chart where, the where the differences. Will become really pronounced, is when you get a chart where the, price is really, moving up and down watch. This as we swing over here to catepillar here's. A stock that's, been moving up and, down and, up and, down and, when you get that you'll see larger. Divergences. Between these, two and. In. That case if a trader is looking for earlier. Signals. For. Entries and for exits, changing. To an exponential, moving average, on a stock that's moving like that may. Give those earlier, entry and exit, signals so. You can see how much of a difference. Or a distinction where we're getting between those, two does. It mean that again that one is better than the other nope it, doesn't mean that at all because. It's. That trade-off, whipsaws. Versus. Faster. Entries and exits. Alright, so let's see what this one's doing right now what's caterpillar been doing most recently, yeah, we have the, exponential, is dipped pretty, solidly, below, the. Simple. If we're, waiting for a closing, price we got close here, if the, if the entry signal we're just on a cross over there, actually would have been an entry signal right, here on, caterpillar. But, then if the exit is, a cross over again, exit. Signal the very next day so you can see that could have been a whipsaw and then, getting right back in again here, so. There's that. Trade-off that we're talking about this. One in this case 10th turned. Out to be a little bit premature although. It, represented. That, entry signal the, very next day but. The, simple also, provided, that entry signal so in this case the trader might say Wow okay so the.
Simple. Saved us some headache there yep. But, at other times the. Simple might cause some. Losses. Look, at this in. This. Case the exponential, is coming down let's. Say that we were in, on a cross over here out, as we cross over again right there, well. We didn't have to absorb the pain of waiting until all this, closed. So. The. Exponential, has, pros and cons simple has pros and cons what I would suggest you do if. This is your first introduction, to simple, versus exponential, moving averages, just, bring up some of the stocks on your watch list and load, up a simple load. Up an exponential, on the, same stock and then, run through a series of stocks, and just just. Apply well what if I got in on a crossover what if I got in on closing value, above. And below those moving. Averages which, one seems to be producing the better signals, for this stock. And. Then you, can switch up the timeframe, alright, we looked at a 20 let's look at a 50 we've. Looked at a 50 let's look at a 10 so, changing. The time frame speeds. Up and slows down, the. Entry and exit signals, and again, that might change. The choice of simple, versus exponential. All. Right well class we've accomplished. Everything that I set out to do I wanted to talk about the construction of simple versus exponential, moving average do, a side-by-side comparison, of, the two we did that, through. Application. To sin. Home Depot caterpillar. Now it's time to go out and get get that repetition, that I would suggest so. If you've enjoyed this presentation this, is what we're gonna be doing in each of my sessions. From here forward just, taking a basic, concept, of technical analysis giving an introduction to that and then exploring, in a little bit greater detail next. Time we're going to be talking about Bollinger. Band bands, which. Is an expansion, on the usage. Of moving averages, it's, it's, an attempt by traders, to, identify, what are normal, ranges. In stock prices that's. What we're gonna be talking about next week I'm looking forward to it if. You feel like you'd like to take your. Technical. Trading up, a step in in intricacy. In in, difficulty. You. May want to check out patent, lolis class two o'clock Eastern Standard Time on Fridays, he. Does a session. Or webcast it's called advanced. Charting, techniques, yeah. I think, that's a great dovetail, for this discussion, but, yeah time for me to set you loose you know what we're doing next time you have your assignment for application. Coming. Up next, in. Just. A little while boy about an hour we have patent lolly again he's gonna be talking with us about, trading. With ETFs. All. Right so if that has, a place in your portfolio, may, want to hang around for that we're gonna take a little bit of a break between this session and the next one so it gives you a time to take. A breather but then come back and check, out Pat's presentation. Also. This is your opportunity you have some time go, follow me on Twitter at CMA, underscore. TDA I try. To post, something to Twitter tweet, every every day of the week if I can, everybody. Let. Me just read through these chats make sure I didn't miss anything Coco, says Kim does today's simple moving average X or exponential moving average change all the time during market hours because the current stock price changing, good, question the answer is yes yep, it does if you watch this not going to move very much because we're using a 50.
Period Moving average so. That's, not going to be as sensitive but if we were to change this Coco to like a really short term like a five day moving average, you'd. See these values changing, a little, more rapid, but. Yeah the short answer is yes thanks, for asking very good question, I. Think. That covers it all right, quick, reminder of the risks associated are investing, as. I. Mentioned earlier risks are real we did use real examples, in today's discussion it's not a recommendation, or endorsement, of those securities, or those strategies, go, enjoy Pat's presentation. I'll look forward to talking with you about Bollinger, Bands next week and of, course you have my invitation, to join me for any of the sessions, I teach between, now and them including. The. Technically, speaking that starts in just a few hours I'm filling. In for John McNichol, in, bounce. And reversal, patterns discussion, so that's coming up right after Pat's, class but. Whenever I see again I want, to wish you the very best of luck happy investing well bye. You.