Moving Averages

Back in the Coach’s Hangout, this is Cory with a mind twister for you. Can the moving average price for a stock go up when the price of the shares goes down? Well, if you’re thinking, “No, that’s not mathematically possible”, then you’re in the same boat as the student who sent in a Coach’s Hangout submission about this, this week. In this video blog I’m going to talk a little bit about moving averages because we actually already have a great mini-lesson on that topic in the learning videos. Don’t worry, I’m not going to leave you hanging, I’ll answer the question that I just asked you a second ago. But first, if the thought of even this basic math of doing an average calculation gives you the chills, I have some good news for you. With the exception of a couple of the more, I say advanced programs, like the Derivatives and Options courses, the majority of the programs that we support here, at SeeWhy Learning, actually involves very little math on the exams.

In fact, in some cases you may only have to use your calculator about four or five times. I know that may be hard to believe given all the numbers and formulas you see in the textbook, and even in our Study Guide. Now, to be clear, I am not advising you to just skip all that math altogether, I still need you to review the content. But if you study hard and understand the concepts behind the math, which of course SeeWhy can help you do, there’s a good chance you could pass your exam, even if you do happen to miss out on all those math marks. All right. Just so we’re all starting from the same place, let’s calculate a simple average together first. So, to calculate an average, you just add up all the numbers you want included, then divide it by the number of numbers there are. I get that may be a little abstract, so let’s throw some numbers on it.

If you wanted to figure out the average temperature over the course of the weekend, and the temperatures were, I don’t know, 24 and 28 degrees. Well, we would just add those together, get 52, and then divide it by two, because that’s how many temperatures we have recorded. We get an average temperature, 26. Make sense? Okay. With that out of the way, let me go ahead and actually pull the question up that the student was asking about. Here it is.

What I want you to do just quickly, is take a look at the numbers and try to answer the question in your head before we really sink our teeth into it. So, what do you think will happen to the moving average price in week seven? Will it go down, will it go up? Will it stay the same or do you think we need more information in order to come up with the answer?

Well, let’s start by actually calculating the five week moving average price for these shares. So, to do that, we just add up all the prices for the last five weeks, weeks three to seven in this case. And then we divide it by the number of weeks, which of course is five. Let’s do that and grab my trusty calculator. We do 14 plus 20, plus 20, plus 23, plus 22, and that gives us $99. Then we divide by five and that gives us $19 and 80 cents. Now it’s beyond the scope of what I want to cover today, but we would take that number, then we plot it on a graph and then we do the same thing next week, and the week after that, and so on to create a moving average line, which a quantitative analyst could use to do what they do.

That’s not the point of this video blog. What’s important is if you followed along with me and feel that you could do the calculation that we just did together, that may, on its own, be good enough to get you the mark on the exam. Look, don’t be intimidated. As long as you understand the process for the average calculation, it’s really just basic addition and division. With that being said, the question isn’t actually asking us what the moving average price is. It’s asking us what happens to the average in week seven. So, I was alluding to this a little bit before, but by understanding the concept you could actually get this mark with doing much math at all. I mean, just look at the numbers. The five week moving average in week six would have included the prices from week two to week six.

Once we get to week 7 and the week 2 price drops off and the week 7 price is included. What do you notice about those two prices? Well, week 2 is $12 and the week 7 price is $22. If you drop a 12 out of an average and replace it with a 22, the average is going to go up. So, by that logic, it should be answer B, it went up. But before we choose that, let’s just run the numbers quickly, just so we’re sure. So, the moving average that we had in week 7 was $19 and 80 cents. So, for week 6 it would be $12, plus $14, plus 20, plus 20, plus 23, that gives us $89. And then we divide that by five and that gives us $17 and 80 cents. So, it went from $17 and 80 cents in week six, up to $19 and 80 cents in week seven.

Good enough for me. And let’s go ahead and choose answer B, and as expected we’re right. Perfect. So, to answer my original question, even though it’s counterintuitive at first glance, the moving average for a stock can go up even if the price goes down and vice versa. Again, it’s not the change from week six to seven, in our case, that matters. It’s the price that’s being added, as compared to the one that’s dropping off. If math isn’t your strong suit, I hope I’ve been able to set your mind about this course at ease, at least a little bit. Or at the very least help you understand moving averages a tiny bit better. Thanks for popping by the Coach’s Hangout everybody and good luck on your exams.