Lecture 4:

Moving Average Method of Forecasting

Forecasting Techniques for Cyclical Series:

• The cyclical effect is the wave –like fluctuation around the trend. The up-down
wave like fluctuations around the trend rarely repeats at fixed intervals of time
and the magnitude of fluctuations also tends to vary. Decomposition methods
(we’ll discuss in later lectures) can be extended to analyze cyclical data.
Forecasting techniques for cyclical data are used whenever the business
cycle influences the variable of interest. Examples are economic markets and
competitive factors.
• Shift in popular tastes occur. Examples are fashion, music and food.
• Shift in population occur. Examples are war, epidemics and natural disasters.
Techniques should be considered when forecasting cyclical series include classical
decomposition, econometric models, multiple regression and ARIMA models etc.
Moving Average method for forecasting :

• Inherent in the collection of data taken over time is some form of

random variation. There exist methods for reducing of canceling the
effect due to random variation. An often-used technique in industry is
"smoothing". This technique, when properly applied, reveals more
clearly the underlying trend, seasonal and cyclic components. Moving
averages is one of the averaging method used to smooth data,
removes random variation, shows trends and cyclic components and
forecast the value for next time period.
Moving Average method for forecasting :

• A moving average of order k is the mean value of the k most

recent observations. It can be used to forecast the next
period by the formula
𝑌𝑡 + 𝑌𝑡−1 + ⋯ + 𝑌𝑡−𝑘+1
𝑌෠𝑡+1 =
𝑘
where 𝑌෠𝑡+1 = forecast value for next period , 𝑌𝑡 =actual
value at period t, k=number of terms in moving average.
Exercise:
• Compute three-year moving
average forecast of the data given
in Example 1 and forecast the
value for 2001.
Example 1: Following is the yearly rentals for the
Movie Video store during 1990-2000:
Years Units Three-year Moving 𝑒𝑡
Rented Moving Total Average
Forecast
(𝑌෠𝑡+1 )
1990 654 - -
1991 658 - -
1992 665 1977 -
1993 672 1995 659 13
1994 673 2010 665 8
1995 671 2016 670 1
1996 693 2037 672 21
1997 694 2058 679 15
1998 701 2088 686 15
1999 703 2098 696 7
2000 702 2106 699 3
Weighted Moving Average Forecast:

• When using a moving average method described before,

each of the observations used to compute the forecasted
value is weighted equally. In certain cases, it might be
beneficial to put more weight on the observations that are
closer to the time period being forecast. When this is done,
this is known as a weighted moving average technique.
Weighted Moving Average Forecast:

• The weights in a weighted MA must sum to 1. It can forecast

the next period by the formula:

𝑌෠𝑡+1 = 𝑤1 𝑌𝑡 + 𝑤2 𝑌𝑡−1 + ⋯ + 𝑤𝑘 𝑌𝑡−𝑘+1

where 𝑤𝑖 i=1,2,….,k represents the weights, σ𝑘𝑖=1 𝑤𝑖 =1

and 𝑤𝑖 ≥ 0.
It is usual practice that in weighted moving average method,
usually the highest weight is given to most recent past value.
Exercise:
• Compute three-year weighted moving average
forecast of the data given in Example 1 with weights
0.5, 0.3 and 0.2 and forecast the value for 2001.
Example 1: Following is the yearly rentals for the
Movie Video store during 1990-2000:
Years Units Three-year Weighted 𝒆𝒕
Rented Weighted Moving
Moving Average Average
(0.5,0.3,0.2) Forecast
(𝑌෠𝑡+1 )
1990 654 - -
1991 658 - -
1992 665 661 -
1993 672 667 661 11
1994 673 671 667 5.9
1995 671 672 671 -0.1
1996 693 682 672 21
1997 694 689 682 12
1998 701 697 689 12
1999 703 701 697 5.7
2000 702 702 701 1.4
Short Term Vs Long Term MA
Moving averages with trends (Double Moving
Averages):
• One way of forecasting time series data that have a
linear trend is to use double moving averages. The
method does what the name implies: One set of
moving averages is computed, and a second set is
then computed as a moving average of the first set.
The double moving average can be computed as
follows:
Computation
• First compute moving average of order k
𝑌𝑡 + 𝑌𝑡−1 + ⋯ + 𝑌𝑡−𝑘+1
𝑀𝑡 =
𝑘
• Using above equation compute second moving
average,
𝑀𝑡 +𝑀𝑡−1 +⋯+𝑀𝑡−𝑘+1
𝑀ሖ 𝑡 =
𝑘
Computation
• Now we compute the values of 𝑎𝑡 and 𝑏𝑡 to make the
forecasts p periods into the future. In this context, 𝑎𝑡 is
computed by adding the difference between the single and
the second moving averages to the single moving average.
i.e.
𝑎𝑡 = 𝑀𝑡 +(𝑀𝑡 − 𝑀ሖ 𝑡 )= 2𝑀𝑡 − 𝑀ሖ 𝑡
and 𝑏𝑡 is computed as follows
2
𝑏𝑡 = (𝑀𝑡 − 𝑀ሖ 𝑡 )
𝑘−1
Example 1: Following is the yearly rentals for the
Movie Video store during 1990-2000:
Years Units Rented Three-year Double
Moving Average Moving at= 2Mt-Mt’ bt=2/(k-1)(Mt-
(Mt) Average (Mt’) Mt’)
1990 654 - -
1991 658 - -
1992 665 659 -
1993 672 665 -
1994 673 670 664.6 675.3 5.33
1995 671 672 669 675 3
1996 693 679 673.7 684.3 5.33
1997 694 686 679 693 7
1998 701 696 687 705 9
1999 703 699.3 693.8 704. 9 5.56
2000 702 702 699.1 704. 9 2.89
Forecasting
• Finally, the equation to make the forecasts p periods into the
future.

෣
𝑌𝑡+𝑝 = 𝑎𝑡 + 𝑏𝑡 𝑝
where k = number of periods in the moving average and
p=number of periods ahead to be forecast.
Exercise
• Use double moving average method on the data given
in Example 1 and compute 1 period ahead forecast.