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Exponential Moving Average vs Simple Moving Average: What's the Difference?

   

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Moving averages are one of the most popular tools that forex traders lean on when attempting to understand market movements because they add an extra layer to any chart analysis you’re conducting, highlighting exactly where the price action is happening.

Based on pure popularity, the exponential moving average (EMA) and the simple moving average (SMA) are the two most common moving average tools. But there are differences between the two. Read on to learn more about SMA vs. EMA.

What Is a Simple Moving Average?

Long before the rise of internet-based trading, the simple moving average was already well established due to its ease of calculation. This is the reasoning behind the name “simple” moving average. An SMA is the average of the closing prices for the time period highlighted. 

On a 20-day SMA, for example, the moving average is the average asset price in that particular date range. The purpose of the SMA is to overlay a chart with long-term price trends to see how current prices compare to a long-term average. In general, longer-term SMAs are more slowly affected by dramatic price swings, whereas shorter-term SMAs will be faster to respond.

Here’s a look at the 50-, 100-, and 200-day SMAs on a CHF/JPY chart. Notice how the 50-day line (in yellow) features more dramatic movements than both the 100-day (in brown) and the 200-day (in purple) lines:

 

Generally speaking, an SMA is calculated using daily closing prices, but it is possible to use other time frames as well, even if they aren’t common. Additional price data, such as the median price and opening price, can also be utilized. At the end of the new price period, that data is added to the calculation, and the oldest price data in the series is eliminated.

SMAs are popular for their ability to easily illustrate the long-term trends of securities over time. If the line is trending up, the security is strengthening, whereas a downward trend shows a weakening of that security. 

Although it can be a useful tool for evaluating a currency pair, the SMA also has limitations due to its reliance on historical data. As a lagging indicator, the data used to create an SMA may already be outdated and less reliable by the time you’re able to view it in a trend line.

Exponential Moving Average vs Simple Moving Average_ What’s the Difference_

What Is an Exponential Moving Average?

Based on the SMA, the EMA gives more importance to recent prices, even if the rate of the decrease between the current price and its preceding price is inconsistent. Think about it this way: Of all moving averages, the exponential moving average is the most “in the moment” because it focuses on the most recent data points.

EMAs are more complicated to calculate because prices closer to the present day receive more weight in the calculation than older prices. This is one benefit of the EMA over the SMA: It leans more heavily on recent historical data rather than giving equal weight to every price within a range. For that reason, the EMA responds faster to price changes in a currency pair.

Below, you will see 20-, 50-, 100-, and 200-day EMA lines on the same CHF/JPY chart as before. Notice how the EMA lines are much more volatile than the lines created by the SMA. This volatility demonstrates the adjusted influence given to recent price changes, which can cause a sudden spike or drop to have an immediate impact on the EMA:

 

The obvious advantage of the EMA is that the data is newer, which means that the insights gained from this indicator are more likely to be relevant for traders. But even though more recent data is given additional weight, EMAs still represent lagging data, and some traders may simply be uninterested in using historical information to guide future trading decisions—especially when so many different factors can affect currency prices.

But the EMA is more complex than the SMA, which is easier for beginning traders to pick up. At the same time, traders focused on a long-term strategy may be fine with the even weight of the SMA because they’re looking at a bigger picture.

What are the key differences between SMA vs. EMA?

You might think that there’s a wealth of differences between EMAs and SMAs, but that isn’t actually the case. The key difference between them is the sensitivity each one shows to shifts in data within its calculations. The EMA places a heavy focus on recent prices, whereas the SMA assigns equal weighting to all values. Both EMAs and SMAs are generally interpreted in the same way, with both used by technically focused traders to smooth out price fluctuations.

The sheer nature of the EMA means that it turns faster than the SMA, and as such, its effectiveness is determined by the period the trader chooses. 

Generally, many traders believe that the EMA edges the SMA, but choosing one over the other depends on what it will be used for.

It’s good to be familiar with both of these indicators, but time will tell whether the EMA or SMA should play a significant role in your trade evaluation strategy. Some traders rely on these indicators heavily, especially when paired with other indicators and chart patterns. Others may go in a different direction and steer clear of the EMA and SMA entirely.

When should you use a simple moving average?

Some may question the use of SMAs these days, but the reality is that they still hold up. What makes them so strong and continually relevant is their versatility. The best way to make use of SMAs is to identify reversals and trends, measure the strength of an asset's momentum, and determine potential areas where an asset will find resistance or support. 

It’s important to remember that, unlike how the EMA gives added weight to more recent prices, SMA weighs the price of each day equally. This makes it an effective tool for long-term trading since it smooths out more recent volatility and takes a wider view of price trends to help you project trade opportunities far into the future. If you want to take a high-level view of a currency pair and forecast price movement over months or years, an SMA is the way to go.

The ability to create custom SMA time frames is also beneficial to traders. They can take several views of a currency pair’s performance over time as they predict future price movements that may occur. While traders can set their own custom time frames based on their trading timelines or goals, many SMA users opt for either the 50-day or 200-day simple moving average, both of which average out prices over that time frame on a rolling basis.

Again, SMAs aren’t the most complicated or sophisticated technical indicator in the world, but they can still provide value as part of a trading strategy.

What are the pros and cons of simple moving averages?

For long-term trade analysis, the greatest benefit of an SMA is that it smooths out price movements and offers a more measured illustration of price trends over time. A single day or two of dramatic price movements isn’t going to significantly alter the SMA, making this indicator a useful resource when looking to remove outliers from your trade analysis and calculations.

The main disadvantage of an SMA is the same as its greatest strength—it depends on the type of trade you’re looking to set up. Short positions are typically not well served by an SMA because it’s too slow to respond to price shifts, which means a good trading opportunity may already pass you by before the SMA reflects that opportunity.

In addition, SMA is a lagging indicator dependent on data that is weeks and months older. In general, this older data is less reliable and predictive of the future.

When should you use an exponential moving average?

EMAs are largely used as a confirmation measure, so they seldom function independently. Many traders use them alongside other indicators to confirm major market moves, validating their legitimacy along the way. 

Since an EMA is typically used for short-term trading analysis, 12-day and 26-day EMAs are the most common time frames used for this indicator. However, in cases where traders want to apply the calculation of an EMA to a long-term trade analysis, time frames most common to SMA charts—such as 50 days and even 200 days—may be used on occasion.

Keep in mind, though, that because an EMA gives added weight to more recent price figures, this indicator will be most useful when trying to assess short-term volatility and the trading opportunities that price movement may create. While you can lengthen an EMA to longer time frames, the best value this offers is in spreading the weighted average of more volatile stocks across a broader span of time—but this is also something you may want to isolate by using a simple moving average covering a 30-day, 50-day, or other shorter time frame.

If you add the EMA to your arsenal of indicators, it’s unlikely to be the first tool you use to evaluate a new trading opportunity. But you may find value in this indicator as you use it to test a hypothesis about a trade or to corroborate or dispute the suggestions made by other indicators.

For traders who lean more on fast-moving markets, EMAs are considered to be highly applicable because they can do a great job of determining trading bias. If you gravitate toward these markets, you may end up using EMAs in a similar way.

What are the pros and cons of exponential moving averages?

For traders seeking short-term wins, an EMA is great because it’s more sensitive to more recent price movements, and it often covers a shorter time frame than simple moving averages. Traders attempting to capitalize on quick price movements can use an EMA effectively to identify opportunities before they pass by.

Although EMA is a lagging indicator, its data can offer more reliability and relevance because of the shorter time frames this indicator typically covers and because more recent prices are weighted to give them greater influence on the chart.

Unfortunately, the volatility and price movements so well depicted by an EMA can also result in a greater risk of false signals. A stop-loss is always recommended when using an EMA to plan out trades given the risk that these false signals may occur.

When can you use SMA and EMA together?

Given the different trading time frames best reflected and analyzed through SMAs and EMAs, most traders use these moving averages separate from one another. If you’re plotting long-term positions, an SMA will be your moving average of choice. For short-term trades, an EMA is better suited to your information needs.

There may be cases, however, where you can use these averages together to evaluate a trade opportunity. For example, an SMA might be used to evaluate the profit potential and momentum of a long-term position you’re looking to open. But even when seeking to go long, an EMA could help you time your trade by identifying the right trading window to open your position ahead of price action.

Traders may prefer this approach if they’re going long but hoping to minimize the time they spend in a given position. Even as an SMA signals long-term growth, you can use an EMA as the indicator that helps you trigger your trading action.

When it comes to indicators, there is no getting away from the sheer commonality of EMAs and SMAs. Any forex trader, no matter their experience level, should be making use of moving averages. Although neither is better or worse than the other, understanding the difference between the two is the key—even if they’re not worlds apart. 

With that knowledge in mind, it comes down to determining which moving average suits your trading approach, so take this information—and don’t be afraid to put it into practice.

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Disclaimer:

The information provided herein is for general informational and educational purposes only. It is not intended and should not be construed to constitute advice. If such information is acted upon by you then this should be solely at your discretion and Valutrades will not be held accountable in any way.

This post was written by Graeme Watkins

CEO Valutrades Limited, Graeme Watkins is an FX and CFD market veteran with more than 10 years experience. Key roles include management, senior systems and controls, sales, project management and operations. Graeme has help significant roles for both brokerages and technology platforms.

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