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Exponential moving average is a method of technical analysis of stocks or others securities that attempts to show the way that a stock has been recently trending. The key to this method is that the most recent stock prices are weighed more heavily in the average than prices from previous days. In this way, exponential moving average, or EMA, differs from the similar simple moving average, which simply calculates the average stock price over a specific period. By adding exponential weight to the most recent stock prices, the EMA reduces the amount of lag time that can distort other moving average calculations.
In order to predict the future performance of a stock, many investors look at its past performance to glean useful information. Moving averages are a popular analytical tool, as they illustrate the behavior of a stock over a given time period and disregard any intangible factors that might distort perception. 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 in day six of a cycle because the day six prices will replace the day one price in calculating the average. With an exponential moving average, the last days of the cycle will have more bearing on the average than the earliest days.
An exponential moving average is calculated using a weighting multiplier, which is determined by adding one to the amount of days in the cycle and then dividing that number into two. For example, if someone wishes to study the EMA over a period of five days, he or she needs to figure out the weighting mutliplier first. In that case, five would be added to one, yielding six, which is then divided into two. The multiplier for that period is 0.333.
It's important to note that the longer the period being studied, the smaller the weighting multiplier will be. This is because the longer period of time makes it less likely that a sudden rise or drop in price reveals an actual trend in the price of the stock. The exponential moving average is thus reached by multiplying the weighting multiplier by the current price and adding that number to the previous day's EMA multiplied by the difference between one and the multiplier.