Exponential moving average (EMA) is a technical analysis method that gives more weight to recent stock prices, reducing lag time. It is calculated using a weight multiplier and is useful for predicting future stock performance.
The exponential moving average is a method of technical analysis of stocks or other securities that attempts to show the trend of a stock recently. The key to this method is that the most recent stock prices are weighted more in the average than the prices of the previous days. In this way, the exponential moving average, or EMA, differs from the similar simple moving average, which simply calculates the average stock price over a specified period. By adding exponential weight to most recent stock prices, the EMA reduces the amount of lag time that can skew other moving average calculations.
To predict the future performance of a stock, many investors look at its past performance for useful information. Moving averages are a popular analytical tool, as they illustrate the behavior of a stock over a given period of time and do not take into account intangible factors that can distort perception. The exponential moving average is a moving average that gives more weight to the most recent data available on a particular stock.
A moving average is named as such because it changes as time passes and older price information is replaced by newer data. For example, a five-day moving average will change on day six of a cycle because the prices on day six will replace the price on day one when calculating the average. With an exponential moving average, the last days of the cycle will have more relation to the average than the first days.
An exponential moving average is calculated using a weight multiplier, which is determined by adding one to the number of days in the cycle and then dividing that number by two. For example, if someone wants to study the EMA over a period of five days, they must first find out the weight multiplier. In that case, five would be added to one, producing six, which is then divided into two. The multiplier for that period is 0.333.
It is important to note that the longer the study period, the lower the weight multiplier. This is because the longer time frame makes it less likely that a sudden rise or fall in price will reveal a real trend in the share price. The exponential moving average is reached by multiplying the weight multiplier by the current price and adding that number to the previous day’s EMA multiplied by the difference between one and the multiplier.
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