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Smoothing is a very common statistical process. In fact, we regularly encounter “smoothed” data in various forms in our day-to-day lives. Any time you use an average to describe something, you are using a smoothed number. If you think about why you use an average to describe something, you will quickly understand the concept of smoothing. For example, we just experienced the warmest winter on record. How are we able to quantify this? Well we start with datasets of the daily high and low temperatures for the period we call “Winter” for each year in recorded history. But that leaves us with a bunch of numbers that jump around quite a bit (it’s not like every day this winter was warmer than the corresponding days from all previous years). We need a number that removes all this “jumping around” from the data so we can more easily compare one winter to the next. Removing the “jumping around” in the data is called smoothing, and in this case we can just use a simple average to accomplish the smoothing.
In demand forecasting, we use smoothing to remove random variation (noise) from our historical demand. This allows us to better identify demand patterns (primarily trend and seasonality) and demand levels that can be used to estimate future demand. The “noise” in demand is the same concept as the daily “jumping around” of the temperature data. Not surprisingly, the most common way people remove noise from demand history is to use a simple average—or more specifically, a moving average. A moving average just uses a predefined number of periods to calculate the average, and those periods move as time passes. For example, if I’m using a 4-month moving average, and today is May 1st, I’m using an average of demand that occurred in January, February, March, and April. On June 1st, I will be using demand from February, March, April, and May.
