Simple vs. Exponential Moving Averages

Now that you know both simple and exponential moving averages, you probably have a lot of questions on your mind. Which one is better? Which one should I use? Well, the answers to these questions are exactly what this lesson is all about.

Let’s start off by comparing these two technical indicators. Through looking at the “how’s” and “why’s,” of each tool, we can gain a better understanding of moving average functionalities and applications. Not to mention how to profit from beneficial moves in price action!

The Simple and Exponential Moving Averages

As you already know, both the simple moving average (SMA) and exponential moving average (EMA) are generally interpreted in the same way. Both are representations of average pricing and both are used by technically-focused traders to interpret market behavior.

However, the key difference between a simple moving average and an exponential moving average is the sensitivity each one shows to the data used by its calculations: the EMA places a heavy focus on recent prices, whereas the SMA assigns an equal weighting to all values. This is a key distinction, as the EMA is viewed as being the more current calculation. Conversely, the SMA is more of a lagging indicator.

Generally speaking, forex traders believe that the exponential moving average edges the simple moving average, but choosing one over the other really depends on what it will be used for. If you’re trading on compressed timeframes, then using an intraday EMA based on closing prices makes sense. On the other hand, swing traders often reference 50-day SMAs based on median values to craft trading decisions.

Ultimately, choosing the correct moving average depends on how you wish to interpret price data within the context of your trading strategies. And, it’s always good to be familiar with both of these indicators; only time will tell whether the EMA or SMA will play a significant role in your trading.

Having said that, let’s learn more about when to use the SMA and EMA.

When to Use a Simple Moving Average (SMA)

Simple moving averages have been around for quite a while but the truth is that they still hold up. SMAs are kind of like COVID-19; they’ve been here for a while and it doesn’t look like they’re going away any time soon.

Anyway, back to SMAs.

What makes them so strong and continually relevant is their versatility. No matter if it is being used as a trend indicator or to establish support and resistance levels, the SMA is a favored tool among forex traders worldwide. In fact, technical forex traders often look to SMAs when identifying reversals and trends, as well as measuring the strength of an asset’s momentum.

In the live market, there are situations where SMAs prove to be exceptional. For instance, the SMA works very well when looking at longer time frames, such as the daily, weekly, monthly, or yearly charts. Why? Because they are smoother and slower, therefore provide traders with a useful picture of the overall trend.

As with all indicators, it’s important to remember that the SMA isn’t perfect. The biggest downside of its application is that it might cause delay and you might miss out on a good entry price or trade. And, unfortunately, being late to the party in forex trading can be costly.

SMAs aren’t the most sophisticated technical indicator in the world. But, they don’t have to be. A good simple moving average can be a great way to sort previous price data and craft trading decisions. While the SMA isn’t the “holy grail” of forex trading, it is capable of providing value as part of a comprehensive trading strategy. Be sure to try it out!

When to Use an Exponential Moving Average

The exponential moving average (EMA) is typically considered more appropriate for short-term trading. Why? Well, the EMA places more weight on more recent price data. So, if you are looking back at ten price inputs, the EMA values the final five more than the first five. In this way, an early series price spike will not have as big of an impact as the most recent data points. Get it?

Functionally, the EMA is a great choice for short-term, intraday traders. Further, if you want a moving average that will respond to the price action rather quickly, then a compressed period EMA is the best way to go. EMAs can also help you catch trends very early (more on this later), which can result in BIG profits. In fact, the earlier you catch a trend, the longer you can ride it and rake in those profits.

The downside of using the EMA is that the moving average itself responds so quickly to the price, you might think a trend is forming when it could be a false signal. That’s why many traders combine the EMA with other technical indicators and avoid the perils of whipsaw consolidation periods.

When using the EMA, there is one basic rule: make sure that your indicator isn’t too fast for your own good!

Average Price Study: SMA vs EMA on a Forex Chart

Let’s have a look at how the 20 EMA compares to the 20 SMA on a daily GBP/USD chart. Visually, both indicators appear almost the same. However, remember that a short-term price movement will have a greater impact on the EMA.

You learned about the simple and exponential moving averages in the previous lessons. We expect your knowledge so far may have stirred up some questions, such as which is better and which you should use. 

In this piece, we help you to answer them and everything else you should know about these tools.

By comparing these two technical indicators, you can learn their functionalities and the more applicable in certain situations. Let’s get right to it. 

The Simple and Exponential Moving Averages

As you already know, the simple moving average (SMA) and exponential moving average (EMA) are generally interpreted similarly. Both are representations of average pricing, and technically focused traders use both to interpret financial market behavior.

However, the key difference between a simple moving average and an exponential moving average is their sensitivity to the data used for the calculations. The EMA places a heavy weight on recent prices while computing the average, while the SMA assigns an equal weight to all values. This is a key distinction, as traders consider the EMA to be more up-to-date with price action. Also, both the EMA and the SMA are a lagging indicator.

Generally speaking, many forex traders believe that the exponential moving average is superior to the simple moving average, but choosing one over the other really depends on the purpose. For instance, if you’re trading on compressed timeframes, then using an intraday EMA based on closing prices makes sense. On the other hand, swing traders often reference the 50-day SMA based on median values to craft trading decisions.

Ultimately, choosing the correct moving average depends on how you wish to interpret price data within the context of your trading strategies. It’s always good to be familiar with both of these indicators. With time, you will be able to tell which of the indicators plays the most significant role in your trading.

In the next section, we will learn more about the most applicable scenarios to use the SMA and EMA.

When to Use a Simple Moving Average (SMA)

The Simple Moving Average has been around for quite a while, but it still meets many traders’ expectations. We expect this to continue for a long time.

What makes them so strong and continually relevant is their versatility. Whether the intent is to use it as a trend indicator or to establish support and resistance levels, the SMA continues to be a favored tool among forex traders worldwide. In fact, technical forex traders often look to the SMA when identifying reversals and trends, as well as measuring the strength of an asset’s momentum.

In the live market, there are situations where the SMA proves to be very exceptional. For instance, the SMA works very well when analyzing the market from a broader perspective, such as the daily, weekly, monthly, or yearly timeframes. This is because the indicator places equal emphasis on price data points across these time periods, providing a smoother and slower chart that cancels out price spikes, thereby giving traders valuable insight into the overall trend.

Traders also consider its adaptability for use on diverse timeframes as beneficial. With this, they can check the performance of a security across different time frames simultaneously to enhance their scope. The 50-day and 200-day SMAs are the most common among many traders as both give an average good enough for making further technical analysis.

As with all indicators, it’s important to remember that the SMA isn’t perfect. The biggest downside of its application is that it might delay in giving signals, causing you to miss out on a good entry price or trade. Unfortunately, being late to the party in forex trading can sometimes be costly.

SMAs aren’t the most sophisticated technical indicator in the world- but they don’t have to be. A good simple moving average can be a great way to sort previous price data and make trading decisions. While the SMA isn’t the “holy grail” of forex trading, it can provide value as part of a comprehensive trading strategy. Be sure to try it out!

When to Use an Exponential Moving Average

Traders consider the exponential moving average (EMA) more appropriate for short-term trading. This is because the EMA places more weight on more recent price data. So, if you are looking back at ten price inputs, the EMA values the final five more than the first five. This way, later series of price volatility will not significantly impact the output as much as the most recent data points.

Functionally, the EMA is a great choice for short-term, intraday traders. If you want a moving average that will respond to the price action more quickly, then a compressed period EMA is the best way to go. EMAs can also help you catch new trends very early, resulting in substantial profits. In fact, the earlier you catch a trend, the longer you can ride it to rake in profit.

The downside of using the EMA is that the moving average responds so quickly to the price that you might think a trend is forming when it could be a false signal. This becomes more noticeable in a ranging market. That’s why many traders combine the EMA with other technical indicators to avoid the perils of the whipsaw consolidation periods.

When using the EMA, always consider that while you require an indicator that can help you detect opportunities quickly, you also do not want an indicator that is too fast for your own good!

Average Price Study: SMA vs EMA on a Forex Chart

Let’s compare the 20 EMA to the 20 SMA on the daily GBP/USD chart. Visually, both indicators appear almost the same. However, remember that a short-term price movement will have a more significant impact on the EMA.

Here is another chart for you, comparing the closing prices for the 50 EMA and the 50 SMA.

Notice that in both charts, the EMA responds more sharply to trend reversals than the SMA. This is true as the EMA crosses the SMA in both a downtrend and an uptrend, reflecting a closer move with price action.

On a side note, though, the charts above show three other valuable concepts that could enhance your trading: convergence, divergence, and crossover. Stick with our course curriculum, and you’ll learn about these key concepts in the coming lessons!

Key Takeaways

• The SMA and EMA indicators both help in identifying price trends and trade opportunities
• The key difference is that the EMA is more sensitive to price changes as it places more emphasis on recent data points.
• The SMA applies an equal weighting to all data points.
• The SMA is best for long-term traders looking at holistic behavior of price action, while the EMA is better for short-term intra-day traders looking to edge out profits from little price changes.
• Both EMA and SMA are helpful tools to enhance your trading experience.

Which Moving Average is Better For Your Trading?

Ultimately, the better trading tool choice comes down to your preference. Best of all, there’s certainly no harm in plotting each one on a chart and seeing how they compare. Both have their own strengths and can be successfully applied in different situations.

Time for recess! Find a chart and start playing with some moving averages!

Try out different types and experiment with different periods. In time, you will find out which moving averages work best for you.

See you in the next lesson!