Moving averages are one of the most popular tools that forex traders lean on when attempting to understand market moments because they add an extra layer to any chart analysis you’re conducting, which furthers your analysis by highlighting exactly where the price action is happening.Based upon pure popularity, the exponential moving average (EMA) and the simple moving average (SMA) are the two most common moving average tools. But there are still differences are between the two.
What Is an Exponential Moving Average?Exponential moving averages give more importance to recent prices, even if the rate of decrease between the current price and its preceding price is not consistent. Think about it this way: Of all moving averages, the exponential moving average is the most “in the moment” because it’s focused upon the most recent data points.
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. Generally speaking, an SMA is calculated using daily closing prices, but it is possible to use other time frames as well, even if it isn’t as 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, while the oldest price data in the series is eliminated.
Understanding the Key Differences
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 such a heavy focus on recent prices, while 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 going to be 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.
When to Use an Exponential Moving AverageEMAs are largely used as a confirmation measure, so they seldom function independently. Many traders will use them alongside other indicators to confirm major market moves, validating the legitimacy of such along the way. For traders who lean more on fast-moving markets, EMAs are considered to be a highly applicable indicator because they can do a great job of determining trading bias.
When to Use a Simple Moving AverageSome may question the use of SMAs these days, but the reality is that in spite of age, they still hold up. What makes them so strong and continually relevant is their versatility as an indicator. 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. Again, these are basic market elements, but SMAs can prove golden at such times when implemented as a part of a trading strategy.
When it comes to indicators, there is no getting away from the sheer commonality of EMAs and SMAs. Any forex trader, no matter the experience level, should be making use of them. Making comparisons between EMAs and SMAs is largely futile, as 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 on board, and don’t be afraid to put it into practice.
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