Exponentially Weighted Moving Averages

What is the difference between a simple moving average and an exponentially weighted moving average?

The fundamental difference between a simple moving average and a weighted moving average is that in the latter each data point is given its own weight so the newest data has a greater weight than the oldest data. It’s a way of saying that recent moves are more relevant than older ones. This makes sense especially as various averages are used to forecast future returns.

We often hear end of year ‘forecasts’ for equity indices. The pension industry uses forecasts of future returns to calculate expected levels of pensions. It could be argued that these aren’t actually ‘forecasts’, rather they are a central expectation of future returns, which usually turn out to be inaccurate.

How does the exponentially weighted moving average change over time?

There is a specific type of moving average that’s normally used in the markets and that’s the exponentially weighted moving average, EWMA.  In an exponentially weighted moving average, the weights decay smoothly, exponentially.