How Do Dividends Affect Moving Averages?

Average

To understand the effect of dividends on a moving average, it is important to understand what an average is. An average, also referred to as a mean, is calculated in order to have a single reference point that represents all the numbers in a particular group. In this case the numbers refer to stock prices in the market.

An average is computed by taking the average price for one day and adding to the average price on the next day. This answer is then divided by two. For instance, if the price of XYZ stock is $10 on day 1 and $20 on day 2, the average is calculated by taking the sum of $10 and $20 and then dividing by 2. The answer is $15.

The moving average is based on a number of days. If the average is over a two-day period it is called a two-day moving average. If the average is over a 10-day period -- that is, if 10 prices are used in the average calculation -- then it is called a 10-day moving average. In keeping with our calculation if the price on day 3 increases to $30, then the two-day moving average is calculated by summing $20 and $30 and then dividing by 2. The answer is $25. So the moving average has increased from $15 to $25.

Dividends are a distribution of funds from the company. As a result, the company usually drops in share price by the exact amount of the dividend. The amount of the dividend payment is low compared to the stock price and so the price of the stock drops when a dividend is distributed from company retained earnings. This causes the price to drop and the moving average to drop as well.