The Method of Moving Averages

The method of moving averages is of two types:

  1. Simple Moving Averages
  2. Weighted Moving Averages

Simple Moving Averages

If the observed values of a variable $Y$ are $y_1, y_2,\cdots, y_n$ corresponding to the time periods $t_1, t_2,\cdots, t_n$, respectively, the $k$-period simple moving averages are defined as

\begin{align*}
a_1 &= \frac{1}{k} \sum_{i=1}^{k} y_i\\
a_2 &= \frac{1}{k} \sum_{i=2}^{k+1} y_i,\\
a_3 &= \frac{1}{k} \sum_{i=3}^{k+2} y_i \\
\vdots &= \quad \vdots\\
a_m &= \frac{1}{k} \sum_{i=m}^{n} y_i
\end{align*}

where $a_1, a_2, \cdots, a_m$ is the sequence of $k$-period simple moving averages. That is, the $k$-period simple moving averages are calculated by averaging the first $k$ observations and then repeating this process of averaging the $k$ observations by dropping each time the first observation and including the next one. This process is continued till the last $k$ observations have been averaged. For example, the 3-period simple moving averages are given as:

\begin{align*}
a_1 &= \frac{1}{3} (y_1+y_2+y_3) = \frac{1}{3} \sum_{i=1}^{3} y_i\\
a_2 &= \frac{1}{3} (y_2+y_3+y_4) = \frac{1}{3} \sum_{i=2}^{4} y_i\\
a_3 &= \frac{1}{3} (y_3+y_4+y_5) = \frac{1}{3} \sum_{i=3}^{5} y_i\\
\vdots &= \quad \vdots\\
\text{and so on}
\end{align*}

Each of these simple moving averages of the sequence $a_1, a_2, a_3,\cdots$ is placed against the middle of each successive group. The $k$-period moving successive totals $S_1, S_2, S_3, \cdots$ are obtained by the following relations

\begin{align*}
S_1 = \sum_{i=1}^{k} y_i\\
S_2 &= S1+ y_{k+1}-y_1\\
S_3 &= S_2 + y_{k+2} – y_2\\
\vdots &= \quad \vdots\\
\text{so on}
\end{align*}

The $k$-period simple moving averages are obtained by dividing these $k$-period moving successive totals ($S_1, S_2, S_3, \cdots$) by $k$, as given in the following relations

\begin{align*}
a_1 &= \frac{S_1}{k}\\
a_2 &= a_1 + \frac{y_{k_1}0y_1} {k}\\
a_3 &= a_2 + \frac{y_{k+2} -y_2}{k}\\
\vdots &= \quad \vdots\\
\text{so on}
\end{align*}

method of moving averages
  • When $k$ is odd, the sequence $a_1, a_2, a_3, \cdots$ will be placed against the middle of its time-period.
  • When $k$ is even, the sequence $a_1, a_2, a_3, \cdots$ of simple moving averages will be placed in the middle of two time periods. It is necessary to centralize these averages. For centralization, further 2-period moving averages of the former $k$-period moving averages are computed which are called $k$-period centered moving averages.

Weighted Moving Averages

For observed values ($y_1, y_2, \cdots, y_n$) of a variable $Y$ corresponding to the time periods $t_1, t_2, \cdots, t_n$, respectively, the $k$-period weighted moving averages with weights $w_1, w_2, \cdots, w_k$ are defined as

\begin{align*}
a_1 &= \frac{1}{\sum w} \sum_{i=1}^{k} y_i w\\
a_2 &= \frac{1}{\sum w} \sum_{i=2}^{k+1} y_i w\\
a_3 &= \frac{1}{\sum w} \sum_{i=3}^{k+2} y_i w\\
\vdots &= \vdots\\
a_m &= \frac{1}{\sum w} \sum_{i=m}^{n} y_i w\\
\end{align*}

where $a_1, a_2, \cdots, a_m$ is a sequence of $k$-period weighted moving averages with weights $w_1, w_2, \cdots, w_k$, respectively. The $k$-period weighted moving averages are calculated by taking the weighted average of the first $k$ observed values with weights $w_1, w_2, \cdots, w_k$ and then repeating this process of averaging the $k$ observations by dropping each time the first observation and including the next one. This process is continued until the last $k$ observations have been averaged.

Merits (Method of Moving Averages)

  • The method of moving averages is simple and easy.
  • This method is appropriate to remove, seasonal variations, cyclical fluctuations, and irregular variations.

Demerits (Method of Moving Averages)

  • Some values at the beginning and the end of the series are lost.
  • Moving averages are greatly affected by extreme values.
  • The method does not provide a mathematical formula for the trend.

Example: Calculate 3-year simple moving averages for the following time series. Also, plot actual data and moving averages on a graph. Also, find the 3-year weighted moving averages with weights 2, 2, and 1, respectively.

Year19701971197219731974197519751977
Production170.0154.8156.6158.9140.3154.2160.7178.3

Solution:

YearProduction3-year Simple MT3-year simple MA3-year WMT3-year WMA
1970170.0    
1971154.8481.3160.43806.1161.22
1972156.5470.2156.73781.5156.30
1973158.9455.7151.90771.1154.22
1974140.3453.4151.13752.6150.52
1975154.2455.2151.73749.7149.94
1976160.7493.2164.40808.1161.62
1977178.3    

*MT=moving total, MA=moving averages, WMT=weighted MT, WMA=Weighted MA

three year moving average

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