Stocks & Commodities V. 2:3 (102-103): FILTER PRICE DATA: Moving Averages vs.

Exponential Moving Averages by Jack K. Hutson

FILTER PRICE DATA: Moving Averages vs.

Exponential Moving Averages
by Jack K. Hutson

I n the process of collecting stock or commodity time series data, such as daily closes, we lose a
significant quantity of information. We are examining a single point (sampling) of price history and
endeavoring to glean some market understanding based only on a single daily price sample. This price
sampling of a trading market frequently distorts the actual price signal. Among the diverse sources of
distortion may be simple record-keeping errors, emotional overflow from other stock issues or
commodities, rumors and political repercussions. Exchange specialists or floor traders also tend to
amplify minor intraday price moves enough to allow them an opportunity to trade, sometimes with a
profit .
Modification of this stream of daily price signals is sometimes necessary to remove the noise and reclaim
the original market message or direction. This process is called filtering. Analyzing how much noise may
be separated from the input data, without destroying the tradable movement, is not simple. A properly
optimized simple linear moving average can often perform as well as an extremely complicated filter.
There are cases where the very best results require an elaborate filter but where only slightly inferior
results can be obtained by using comparatively simple filters.
When examining stock price historic data, it is common to look only at a plot of weekly ranges.
Sometimes Friday's closing price is shown as a small tick to the right or simply a cross on the weekly bar
chart. By not plotting daily price ranges, we have applied a simple visual weekly filter to otherwise hectic
daily trading.
The average age (K) of data used in a simple linear weighted moving average is as follows:

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Stocks & Commodities V. 2:3 (102-103): FILTER PRICE DATA: Moving Averages vs. Exponential Moving Averages by Jack K. Hutson

N- 1
K=
2
Where: N = Number of days of past data averaged. K = Average 'Age' of past data.
The average age (K) of data used in single exponentially smoothed data is:

1- a1
K=
a1
a1= Single exponential smoothing factor.
The average age (K) of a moving average and single exponential smoothing may be used to define an
equivalence relationship as follows:

1- a1 N- 1
=
a1 2
What I have done here is to make an assumption about two moving average weighting schemes. A linear
weighted moving average uses each day's past price to compute an equally weighted average. This
average should most logically be plotted half way back (centered) from the most recent day's price,
resulting in an average that constantly trails current price action.
On the other hand, a moving average that weights past prices exponentially makes sense in that the older
the data the less weight it will have on the average. This method of filtering has an intuitive appeal to
businessmen, including traders, because it places more importance on increasingly recent historical
information. The use of this more esoteric weighting idea has been used a great deal in business because
of its easy implementation on a small programmable calculator or computer. The other main advantages
to using an exponential weighted moving average are its ease of daily update and the smaller degree of
plotting lag.
Thus the single exponential smoothing factor (a1) may be approximated in terms of a more familiar
linear moving average length (N).

1 2
α1 = =
N-1
+ 1 N+1
2
In addition to using a single exponential, one may also explore more complex recursive and higher order
exponential weighting based on more than just a multiple of yesterday's price. For example, triple
exponential smoothing is based on a weighting of the past three day's prices (order of 3). To further
extend this average data age relationship to multiple exponential smoothing, the following equation may
be used:

(1 - αp) p = 1 - α1
P = Order of exponential smoothing
(i.e P = 3 for triple)
Or in terms of (N) moving average

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Stocks & Commodities V. 2:3 (102-103): FILTER PRICE DATA: Moving Averages vs. Exponential Moving Averages by Jack K. Hutson

2
αp = 1- p 1-
N+1

Alpha (α) is the smoothing factor, in exponential smoothing, that controls the number of past days of
data (such as closing prices) that have any effect on the forecast or average.

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Stocks & Commodities V. 2:3 (102-103): FILTER PRICE DATA: Moving Averages vs. Exponential Moving Averages by Jack K. Hutson

Brown, Robert G., Smoothing, Forecasting and Prediction of Discrete Time Series , Englewood Cliffs,
NJ.: Prentice-Hall, Inc., 1963.

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