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!
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.
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!
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!
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.
We know that as a Forex trader, you love charts. Here’s another one for you. This time, we’ll compare the closing prices for the 50 EMA and the 50 SMA.
There are three big takeaways from the moving averages on the chart above: convergence, divergence, and crossover. Stick with our course curriculum and you’ll learn all about these key concepts in coming lessons!
So, which is best? The EMA or SMA? Ultimately, the choice comes down to YOUR personal 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!