Moving Average Methods

One of the easiest, most common time series forecasting techniques is that of the moving average. Moving
average methods come in handy if all you have is several consecutive periods of the variable (e.g., sales, new
savings accounts opened, workshop attendees, etc.) youre forecasting, and no other data to predict what the
next periods value will be. Often, using the past few months of sales to predict the coming months sales is
preferable to unaided estimates. However, moving average methods can have serious forecasting errors
if applied carelessly.
Moving Averages: The Method
Essentially, moving averages try to estimate the next periods value by averaging the value of the last couple
of periods immediately prior. Lets say that you have been in business for three months, January through
March, and wanted to forecast Aprils sales. Your sales for the last three months look like this:

Month
Sales ($000)
129
January
134
February
122
March
The simplest approach would be to take the average of January through March and use that to estimate
Aprils sales:
(129 + 134 + 122)/3 = $128.333

Hence, based on the sales of January through March, you predict that sales in April will be $128,333. Once
Aprils actual sales come in, you would then compute the forecast for May, this time using February through
April. You must be consistent with the number of periods you use for moving average forecasting.
The number of periods you use in your moving average forecasts are arbitrary; you may use only twoperiods, or five or six periods whatever you desire to generate your forecasts.
The approach above is a simple moving average. Sometimes, more recent months sales may be stronger
influencers of the coming months sales, so you want to give those nearer months more weight in your
forecast model. This is a weighted moving average. And just like the number of periods, the weights you assign
are purely arbitrary. Lets say you wanted to give Marchs sales 50% weight, Februarys 30% weight, and
Januarys 20%. Then your forecast for April will be $127,000 [(122*.50) + (134*.30) + (129*.20) = 127].

Limitations of Moving Average Methods

Moving averages are considered a smoothing forecast technique. Because youre taking an average over
time, you are softening (or smoothing out) the effects of irregular occurrences within the data. As a result, the
effects of seasonality, business cycles, and other random events can dramatically increase forecast error. Take
a look at a full years worth of data, and compare a 3-period moving average and a 5-period moving average:

Month
Sales ($000) 3-Mo. Moving Average 5-Mo. Moving Average
129
January
134
128.3
February
122
127.0
128.2
March
125
126.0
129.8
April
131
131.0
128.6
May
137
132.0
130.4
June
128
132.0
129.2
July
131
126.0
127.8
August
119
124.7
126.0
September
124
123.7
127.6
October
128
129.3
November
136
December
Notice that in this instance that I did not create forecasts, but rathercentered the moving averages. The first
3-month moving average is for February, and its the average of January, February, and March. I also did
similar for the 5-month average. Now take a look at the following chart:

What do you see? Is not the three-month moving average series much smoother than the actual sales series?
And how about the five-month moving average? Its even smoother. Hence, the more periods you use in your
moving average, the smoother your time series. Hence, for forecasting, a simple moving average may not be
the most accurate method. Moving average methods do prove quite valuable when youre trying to extract the
seasonal, irregular, and cyclical components of a time series for more advanced forecasting methods, like
regression and ARIMA, and the use of moving averages in decomposing a time series will be addressed later
in the series.

Determining the Accuracy of a Moving Average Model

Generally, you want a forecasting method that has the least error between actual and predicted results. One
of the most common measures of forecast accuracy is the Mean Absolute Deviation (MAD). In this approach,
for each period in the time series for which you generated a forecast, you take the absolute value of the
difference between that periods actual and forecasted values (the deviation). Then you average those
absolute deviations and you get a measure of MAD. MAD can be helpful in deciding on the number of periods
you average, and/or the amount of weight you place on each period. Generally, you pick the one that results
in the lowest MAD. Heres an example of how MAD is calculated:

Month
Actual 3-Mo. Forecast Deviation Absolute Deviation
135
127
(8)
8
January
135
1
1
February 134
125
128
3
3
March
MAD= 4
MAD is simply the average of 8, 1, and 3.
Moving Averages: Recap
When using moving averages for forecasting, remember:
1.

Moving averages can be simple or weighted;

2.

The number of periods you use for your average, and any weights you assign to each are strictly arbitrary;

3.

Moving averages smooth out irregular patterns in time series data; the larger the number of periods used
for each data point, the greater the smoothing effect;

4.

Because of smoothing, forecasting next months sales based on the most recent few months sales can result
in large deviations because of seasonality, cyclical, and irregular patterns in the data; and

5.

The smoothing capabilities of a moving average method can be useful in decomposing a time series for
more advanced forecasting methods.