Ask Colin

What is the difference between the 260 day moving average and the 12 month moving average?

The detailed question was:

Part of one of your Ask Colin answers was one is the 260-day moving average (which may be used on weekly data as a 52-week moving average or on monthly data as a 12 month moving average) What is the difference between the 260 day moving average (i.e. the number of days the stock market is open for trading in 12 months) and the 12 month moving average?

This is a really important concept to understand.

Trading on the stock market is in the form of transactions, each one of which is discrete. It is a convention that we summarise any period of trading by four data points: the opening price, the highest price, the lowest price and the last price. Notice that I said period. A period is most commonly a day, a week or a month. However, it can also be shorter than that - short term traders use five minutes, ten minutes, and hour etc. It can also occasionally be longer than that - a quarter or even a year.

The parameter of a moving average is the period the calculation looks back and calculates an average for.

The most common form of the calculation is where the period is a day, so to get a moving average for a year of trading, we would use 260 days. This is 52 week multiplied by 5 days per week. This is technically more than a year, because it does not allow for holidays. However, it is close enough for the purpose.

However, sometimes the data we are using will be in the form of weekly periods. If we use 260, we will be averaging the closing prices for 260 weeks and so the average will cover about five years instead of one year. To deal with this, we use 52, which is the number of weekly periods in a year. This moving average will be very similar to that for the 260-day calculation, but not the same. The differences will derive from the slightly longer period on the 260-day calculation (the effect of holidays disappears in the weekly calculation), but more importantly because the 52 data points on the weekly calculation may eliminate some fairly extreme volatility on some daily closes, all of which are in the daily calculation.

Similarly, sometimes the data is in the form of monthly periods. Here, we need to use 12 periods, so that the look back period is still one year.

You might argue that we should always just use daily periods. For a moving average, it does not make much difference. However, for other indicators, it is quite critical. It will depend on your trading/investing timeframe, which you use. Good charting software should enable you to calculate daily, weekly or monthly indicators so you can see the short, medium and long term pictures.