As a first step in moving beyond mean models, random walk models, and linear trend

models, nonseasonal patterns and trends can be extrapolated using a moving-average or

smoothing model. The basic assumption behind averaging and smoothing models is that
the time series is locally stationary with a slowly varying mean. Hence, we take a
moving (local) average to estimate the current value of the mean and then use that as
the forecast for the near future. This can be considered as a compromise between the
mean model and the random-walk-without-drift-model. The same strategy can be used
to estimate and extrapolate a local trend. A moving average is often called a
"smoothed" version of the original series because short-term averaging has the effect of
smoothing out the bumps in the original series. By adjusting the degree of smoothing
(the width of the moving average), we can hope to strike some kind of optimal balance
between the performance of the mean and random walk models. The simplest kind of
averaging model is the....

Simple (equally-weighted) Moving Average:

The forecast for the value of Y at time t+1 that is made at time t equals the simple
average of the most recent m observations:

(Here and elsewhere I will use the symbol Y-hat to stand for a forecast of the time
series Y made at the earliest possible prior date by a given model.) This average is
centered at period t-(m+1)/2, which implies that the estimate of the local mean will tend
to lag behind the true value of the local mean by about (m+1)/2 periods. Thus, we say
the average age of the data in the simple moving average is (m+1)/2 relative to
the period for which the forecast is computed: this is the amount of time by which
forecasts will tend to lag behind turning points in the data. For example, if you are
averaging the last 5 values, the forecasts will be about 3 periods late in responding to
turning points. Note that if m=1, the simple moving average (SMA) model is equivalent
to the random walk model (without growth). If m is very large (comparable to the length
of the estimation period), the SMA model is equivalent to the mean model. As with any
parameter of a forecasting model, it is customary to adjust the value of k in order to
obtain the best "fit" to the data, i.e., the smallest forecast errors on average.

Here is an example of a series which appears to exhibit random fluctuations around a

slowly-varying mean. First, let's try to fit it with a random walk model, which is
equivalent to a simple moving average of 1 term:

The random walk model responds very quickly to changes in the series, but in so doing it
picks much of the "noise" in the data (the random fluctuations) as well as the "signal"
(the local mean). If we instead try a simple moving average of 5 terms, we get a
smoother-looking set of forecasts:

The 5-term simple moving average yields significantly smaller errors than the random
walk model in this case. The average age of the data in this forecast is 3 (=(5+1)/2), so
that it tends to lag behind turning points by about three periods. (For example, a
downturn seems to have occurred at period 21, but the forecasts do not turn around
until several periods later.)

Notice that the long-term forecasts from the SMA model are a horizontal straight line,
just as in the random walk model. Thus, the SMA model assumes that there is no trend
in the data. However, whereas the forecasts from the random walk model are simply
equal to the last observed value, the forecasts from the SMA model are equal to a
weighted average of recent values.
The confidence limits computed by Statgraphics for the long-term forecasts of the
simple moving average do not get wider as the forecasting horizon increases. This is
obviously not correct! Unfortunately, there is no underlying statistical theory that tells us
how the confidence intervals ought to widen for this model. However, it is not too hard
to calculate empirical estimates of the confidence limits for the longer-horizon forecasts.
For example, you could set up a spreadsheet in which the SMA model would be used to
forecast 2 steps ahead, 3 steps ahead, etc., within the historical data sample. You could
then compute the sample standard deviations of the errors at each forecast horizon, and

then construct confidence intervals for longer-term forecasts by adding and subtracting
multiples of the appropriate standard deviation.

If we try a 9-term simple moving average, we get even smoother forecasts and more of
a lagging effect:

The average age is now 5 periods (=(9+1)/2). If we take a 19-term moving average, the
average age increases to 10:

Notice that, indeed, the forecasts are now lagging behind turning points by about 10
periods.
Which amount of smoothing is best for this series? Here is a table that compares their
error statistics, also including a 3-term average:

Model C, the 5-term moving average, yields the lowest value of RMSE by a small margin
over the 3-term and 9-term averages, and their other stats are nearly identical. So,
among models with very similar error statistics, we can choose whether we would prefer
a little more responsiveness or a little more smoothness in the forecasts. (Return to top
of page.)

Brown's Simple Exponential Smoothing (exponentially weighted moving

average)
The simple moving average model described above has the undesirable property that it
treats the last k observations equally and completely ignores all preceding observations.
Intuitively, past data should be discounted in a more gradual fashion--for example, the
most recent observation should get a little more weight than 2nd most recent, and the
2nd most recent should get a little more weight than the 3rd most recent, and so on.
The simple exponential smoothing (SES) model accomplishes this.
Let denote a "smoothing constant" (a number between 0 and 1). One way to write the
model is to define a series L that represents the current level (i.e., local mean value) of
the series as estimated from data up to the present. The value of L at time t is
computed recursively from its own previous value like this:

Lt = Yt + (1) Lt-1
Thus, the current smoothed value is an interpolation between the previous smoothed
value and the current observation, where controls the closeness of the interpolated
value to the most recent observation. The forecast for the next period is simply the
current smoothed value:

Equivalently, we can express the next forecast directly in terms of previous forecasts and
previous observations, in any of the following equivalent versions. In the first version,
the forecast is an interpolation between previous forecast and previous observation:

In the second version, the next forecast is obtained by adjusting the previous forecast in
the direction of the previous error by a fractional amount :

where

is the error made at time t. In the third version, the forecast is an exponentially
weighted (i.e. discounted) moving average with discount factor 1-:

The interpolation version of the forecasting formula is the simplest to use if you are
implementing the model on a spreadsheet: it fits in a single cell and contains cell
references pointing to the previous forecast, the previous observation, and the cell where
the value of is stored.
Note that if =1, the SES model is equivalent to a random walk model (without growth).
If =0, the SES model is equivalent to the mean model, assuming that the first
smoothed value is set equal to the mean. (Return to top of page.)

The average age of the data in the simple-exponential-smoothing forecast is

1/ relative to the period for which the forecast is computed. (This is not supposed to be
obvious, but it can easily be shown by evaluating an infinite series.) Hence, the simple
moving average forecast tends to lag behind turning points by about 1/ periods. For
example, when =0.5 the lag is 2 periods; when =0.2 the lag is 5 periods; when =0.1
the lag is 10 periods, and so on.
For a given average age (i.e., amount of lag), the simple exponential smoothing (SES)
forecast is somewhat superior to the simple moving average (SMA) forecast because it
places relatively more weight on the most recent observation--i.e., it is slightly more
"responsive" to changes occuring in the recent past. For example, an SMA model with
9 terms and an SES model with =0.2 both have an average age of 5 for the
data in their forecasts, but the SES model puts more weight on the last 3 values than
does the SMA model and at the same time it doesnt entirely forget about values more
than 9 periods old, as shown in this chart:

Another important advantage of the SES model over the SMA model is that the SES
model uses a smoothing parameter which is continuously variable, so it can easily
optimized by using a "solver" algorithm to minimize the mean squared error. The optimal
value of in the SES model for this series turns out to be 0.2961, as shown here:

The average age of the data in this forecast is 1/0.2961 = 3.4 periods, which is similar to
that of a 6-term simple moving average.

The long-term forecasts from the SES model are a horizontal straight line, as in the SMA
model and the random walk model without growth. However, note that the confidence
intervals computed by Statgraphics now diverge in a reasonable-looking fashion, and
that they are substantially narrower than the confidence intervals for the random walk
model. The SES model assumes that the series is somewhat "more predictable" than
does the random walk model.
An SES model is actually a special case of an ARIMA model, so the statistical theory of
ARIMA models provides a sound basis for calculating confidence intervals for the SES
model. In particular, an SES model is an ARIMA model with one nonseasonal
difference, an MA(1) term, and no constant term, otherwise known as an

"ARIMA(0,1,1) model without constant". The MA(1) coefficient in the ARIMA model
corresponds to the quantity 1- in the SES model. For example, if you fit an
ARIMA(0,1,1) model without constant to the series analyzed here, the estimated MA(1)
coefficient turns out to be 0.7029, which is almost exactly one minus 0.2961.
It is possible to add the assumption of a non-zero constant linear trend to an SES
model. To do this, just specify an ARIMA model with one nonseasonal difference and an
MA(1) term with a constant, i.e., an ARIMA(0,1,1) model with constant. The long-term
forecasts will then have a trend which is equal to the average trend observed over the
entire estimation period. You cannot do this in conjunction with seasonal adjustment,
because the seasonal adjustment options are disabled when the model type is set to
ARIMA. However, you can add a constant long-term exponential trend to a simple
exponential smoothing model (with or without seasonal adjustment) by using the
inflation adjustment option in the Forecasting procedure. The appropriate "inflation"
(percentage growth) rate per period can be estimated as the slope coefficient in a linear
trend model fitted to the data in conjunction with a natural logarithm transformation, or
it can be based on other, independent information concerning long-term growth
prospects. (Return to top of page.)

Brown's Linear (i.e., double) Exponential Smoothing

The SMA models and SES models assume that there is no trend of any kind in the data
(which is usually OK or at least not-too-bad for 1-step-ahead forecasts when the data is
relatively noisy), and they can be modified to incorporate a constant linear trend as
shown above. What about short-term trends? If a series displays a varying rate of
growth or a cyclical pattern that stands out clearly against the noise, and if there is a
need to forecast more than 1 period ahead, then estimation of a local trend might also
be an issue. The simple exponential smoothing model can be generalized to obtain a
linear exponential smoothing (LES) model that computes local estimates of both level
and trend.

The simplest time-varying trend model is Brown's linear exponential smoothing

model, which uses two different smoothed series that are centered at different points in
time. The forecasting formula is based on an extrapolation of a line through the two
centers. (A more sophisticated version of this model, Holts, is discussed below.)

The algebraic form of Browns linear exponential smoothing model, like that of the simple
exponential smoothing model, can be expressed in a number of different but equivalent
forms. The "standard" form of this model is usually expressed as follows: Let S' denote
the singly-smoothed series obtained by applying simple exponential smoothing to series
Y. That is, the value of S' at period t is given by:

(Recall that, under simple exponential smoothing, this would be the forecast for Y at
period t+1.) Then let S" denote the doubly-smoothed series obtained by applying simple
exponential smoothing (using the same ) to series S':

Finally, the forecast for Yt+k, for any k>1, is given by:

where:

...is the estimated level at period t, and

...is the estimated trend at period t.

For purposes of model-fitting (i.e., calculating forecasts, residuals, and residual statistics
over the estimation period), the model can be started up by setting S'1 = S''1 = Y1, i.e.,
set both smoothed series equal to the observed value at t=1. (Return to top of page.)

A mathematically equivalent form of Brown's linear exponential smoothing model,

which emphasizes its non-stationary character and is easier to implement on a
spreadsheet, is the following:

or equivalently:

In other words, the predicted difference at period t is equal to the previous observed
difference minus a weighted difference of the two previous forecast errors.
Caution: this form of the model is rather tricky to start up at the beginning of the
estimation period. The following convention is recommended:

This yields e1 = 0 (i.e., cheat a bit, and let the first forecast equal the actual first
observation), and e2 = Y2 Y1, after which forecasts are generated using the equation
above. This yields the same fitted values as the formula based on S' and S'' if the latter
were started up using S'1 = S''1 = Y1. This version of the model is used on the next
page that illustrates a combination of exponential smoothing with seasonal adjustment.

Holts Linear Exponential Smoothing

Browns LES model computes local estimates of level and trend by smoothing the recent
data, but the fact that it does so with a single smoothing parameter places a constraint
on the data patterns that it is able to fit: the level and trend are not allowed to vary at
independent rates. Holts LES model addresses this issue by including two smoothing
constants, one for the level and one for the trend. At any time t, as in Browns model,
the there is an estimate Lt of the local level and an estimate T t of the local trend. Here
they are computed recursively from the value of Y observed at time t and the previous
estimates of the level and trend by two equations that apply exponential smoothing to
them separately.

If the estimated level and trend at time t-1 are L t-1 and Tt-1, respectively, then the
forecast for Yt that would have been made at time t-1 is equal to L t-1+Tt-1. When the
actual value is observed, the updated estimate of the level is computed recursively by
interpolating between Yt and its forecast, Lt-1+Tt-1, using weights of and 1-:

The change in the estimated level, namely L t - Lt-1, can be interpreted as a noisy
measurement of the trend at time t. The updated estimate of the trend is then
computed recursively by interpolating between L t - Lt-1 and the previous estimate of the
trend, Tt-1, using weights of and 1-:

Finally, the forecasts for the near future that are made from time t are obtained by
extrapolation of the updated level and trend:

The interpretation of the trend-smoothing constant is analogous to that of the levelsmoothing constant . Models with small values of assume that the trend changes
only very slowly over time, while models with larger assume that it is changing more
rapidly. A model with a large believes that the distant future is very uncertain,
because errors in trend-estimation become quite important when forecasting more than
one period ahead. (Return to top of page.)

The smoothing constants and can be estimated in the usual way by minimizing the
mean squared error of the 1-step-ahead forecasts. When this done in Statgraphics, the
estimates turn out to be =0.3048 and =0.008. The very small value of means
that the model assumes very little change in the trend from one period to the next, so
basically this model is trying to estimate a long-term trend. By analogy with the notion
of the average age of the data that is used in estimating the local level of the series, the
average age of the data that is used in estimating the local trend is proportional to 1/ ,
although not exactly equal to it. In this case that turns out to be 1/0.006 = 125. This
isnt a very precise number inasmuch as the accuracy of the estimate of isnt really 3
decimal places, but it is of the same general order of magnitude as the sample size of
100, so this model is averaging over quite a lot of history in estimating the trend. The
forecast plot below shows that the LES model estimates a slightly larger local trend at
the end of the series than the constant trend estimated in the SES+trend model. Also,
the estimated value of is almost identical to the one obtained by fitting the SES model
with or without trend, so this is almost the same model.

Now, do these look like reasonable forecasts for a model that is supposed to be
estimating a local trend? If you eyeball this plot, it looks as though the local trend has
turned downward at the end of the series! What has happened? The parameters of this
model have been estimated by minimizing the squared error of 1-step-ahead forecasts,
not longer-term forecasts, in which case the trend doesnt make a lot of difference. If all
you are looking at are 1-step-ahead errors, you are not seeing the bigger picture of
trends over (say) 10 or 20 periods. In order to get this model more in tune with our
eyeball extrapolation of the data, we can manually adjust the trend-smoothing constant
so that it uses a shorter baseline for trend estimation. For example, if we choose to set
=0.1, then the average age of the data used in estimating the local trend is 10
periods, which means that we are averaging the trend over that last 20 periods or so.
Heres what the forecast plot looks like if we set =0.1 while keeping =0.3. This looks
intuitively reasonable for this series, although it is probably dangerous to extrapolate this
trend any more than 10 periods in the future.

What about the error stats? Here is a model comparison for the two models shown
above as well as three SES models. The optimal value of .for the SES model is
approximately 0.3, but similar results (with slightly more or less responsiveness,
respectively) are obtained with 0.5 and 0.2.

Models
(A) Holt's linear exp. smoothing with alpha = 0.3048 and beta = 0.008
(B) Holt's linear exp. smoothing with alpha = 0.3 and beta = 0.1
(C) Simple exponential smoothing with alpha = 0.5
(D) Simple exponential smoothing with alpha = 0.3
(E) Simple exponential smoothing with alpha = 0.2

Estimation Period

Model

RMSE

MAE

MAPE

ME

MPE

(A)

98.9302

76.3795

16.418

-6.58179

-7.0742

(B)

100.863

78.3464

16.047

-3.78268

-5.63482

(C)

101.053

76.7164

14.605

1.70418

-4.94903

(D)

98.3782

75.0551

18.9899

3.21634

-4.85287

(E)

99.5981

76.3239

12.528

5.20827

-4.7815

Model

RMSE

RUNS

RUNM

AUTO

MEAN

VAR

(A)

98.9302

OK

OK

OK

OK

OK

(B)

100.863

OK

OK

OK

OK

OK

(C)

101.053

OK

OK

OK

OK

OK

(D)

98.3782

OK

OK

OK

OK

OK

(E)

99.5981

OK

OK

OK

OK

Their stats are nearly identical, so we really cant make the choice on the basis of 1step-ahead forecast errors within the data sample. We have to fall back on other
considerations. If we strongly believe that it makes sense to base the current trend
estimate on what has happened over the last 20 periods or so, we can make a case for
the LES model with = 0.3 and = 0.1. If we want to be agnostic about whether there
is a local trend, then one of the SES models might be easier to explain and would also
give more middle-of-the-road forecasts for the next 5 or 10 periods.