The Two Types of Moving Average

There are different types of moving averages depending on the smoothness of the curve.

  1. Simple Moving Average (SMA)
  2. Exponential Moving Average (EMA)

Simple Moving Average

A simple moving average is a moving average that is derived by adding the closing prices of a given number of periods and diving it by the number of periods.

For instance, you can calculate the simple moving average by adding the closing prices of 30-minute periods for the past, say 2 hours. This will give you 4 periods of a 30-minute chart (120mins/30mins). Thus, you can divide the sum of all the closing prices by 4 to give you the average closing prices.

When these average points are joined together, it creates a simple moving average.

Don’t worry if it is confusing, your account will calculate these for you automatically. What you need to do on your chart is just to click on the simple average indicator and input the periods you want the SMA to be based.

Simple Moving Average in forex trading

The chart above shows three simple moving average lines. The yellow one is a 30-periods SMA, the pink one is a 62-periods SMA, while the blue one is a 5-periods SMA.

From the chart, you can see that the longer the period of the simple moving average, the more it falls below the actual price.

The 62 SMA falls far away from the other two SMAs. The 62 SMA adds the closing prices of 62 periods and divides the sum by 62.

A simple moving average shows the overall sentiment of the market at a given time. From the chart above, the sentiment of the market is an upward trend.

The disadvantage of a simple moving average is that it may give a false signal of the market sentiment because it does not capture recent events. For instance, if news come up temporarily about the U.S., the dollar might change its direction, and the simple moving average fails to capture that. Such events can wipe out profits.

Exponential Moving Average

While the simple moving average is too simple, the exponential moving average (EMA) captures the details of the most recent periods in market. Spikes of a certain period does not affect the recent prices. An EMA and an SMA are shown side by side below.

simple moving average and exponential moving average in forex trading

The 30 SMA is shown by the blue line, and it is further from the actual price than the 30 EMA in red. Thus, an EMA captures the most recent price actions compared to the SMA.

The exponential moving averages emphasizes the most recent occurrences in the market, which are ignored by the simple moving average.

The downside of an EMA is that it can cause false hopes as it responds to price changes quickly. You may think a trend is forming, but it could be just spikes caused by recent events. So you may respond to temporary changes, and suddenly the market retraces to its original movement, and you lose.

Points to Note when Using SMAs and EMAs

  • A short period EMA responds to price actions quickly
  • A longer period SMA responds slowly to price action.
  • An SMA is suitable for traders who are looking at longer time frames
  • An EMA is suitable for traders who are looking for a short time frame.

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