18 May, 2020, | AtoZ Markets - Financial markets, including the Forex market move due to the difference between supply and demand. Therefore, to survive in the market, a retail trader should follow what the big players are doing. Moving average is the technical indicator that provides the average price of the last selected number of candles. The most used moving average types are EMA and SMA.
WARNING: Some Forex brokers will manipulate the daily moving averages, by showing additional candles for Monday market opening.
What is an SMA?
SMA stands for the simple moving average. A simple moving average is the simple calculation of the last few candles. It comes by dividing the sum of the values by the number of values. Moreover, the simple moving average rejects older values as newer values. The formula of SMA is mentioned-below-
Simple moving average = (P1 + P2 + P3 + P4 + ... + Pn) / n
Whether you are using MT4 or MT5 trading platforms, the simple moving average is always free to use. It will come as a default indicator on your trading platform.
What is an EMA?
The EMA stands for exponential moving averages. It is slightly different than SMA. The calculation of the EMA is different when it is plotted in the chart. The formula for EMA is mentioned below-
Exponential moving average = (Close - previous EMA) * (2 / n+1) + previous EMA
The significant difference between the EMA and SMA is that SMA treats all prices in the ‘n’ period. On the other hand, EMA provides a depth insight into the most recent prices out of ‘n’ prices.
Moreover, there are some other differences that rise a question- is EMA better than SMA?
So, what is the difference between EMA and SMA? Which moving average should you use?
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Is EMA better than SMA?
As we have seen earlier, EMA and SMA are both important trend trading indicators, and most of the professional traders use it. Often one being better than the other one will depend on your strategy.
Despite being simple, these indicators have a significant impact on technical analysis. The EMA has bigger emphasis on most recent prices, which makes it compelling by some traders. However, but there are other elements you need to consider before prioritizing EMA over SMA.
EMA focuses on the latest price movements
The SMA is the average price of a currency pair over a given period. For example, we can calculate the 20-daily moving average by adding the daily closing prices of the last 20-days and dividing the value by 20. As the number is re-calculated, new data becomes available, known as “moving average.”
Besides this basic calculation of EMA vs SMA, the exponential moving average adds a component by giving the current prices more weight to reflect new market data accurately. Therefore, the difference between the EMA and SMA is the most noticeable in the long-run.
As a result, EMAs provides better results than the SMAs for short-term traders like day traders and scalpers. However, for swing trading or position trading traders prefer using SMAs.
SMA Measures the Golden Cross
As we have seen earlier, that simple moving average provides better results for measuring the trend in higher timeframes. Therefore, the golden cross comes by determining the behaviour of short-term and long-term moving averages.
What is the Golden Cross?
The golden cross is a candlestick pattern that comes when a relatively short-term moving average crosses the long-term moving average. The most commonly used moving averages values are 50 SMA to indicate a short-term trend and the 200 SMA for the long-term trend. The longer timeframe means traders with higher volumes and strength. Therefore, when the short-term traders match with their direction, the probability goes high.
For example, the 50-day moving average crossover and the 200-day moving average on the currency pair like EURUSD provide the potential market trend.
In the example above, we can see how the 50 SMA crosses the 200 SMA in the daily timeframe and starts a strong bearish trend.
EMA is Better as Dynamic Levels
As we know, moving averages are trend trading indicators; it provides a better accuracy trend reading beside the traditional static support and resistance levels. As a result, most of the price action and day traders use this indicator.
However, in EMA vs SMA discussion, traders use EMA as a dynamic level, emphasizing the most recent prices. The currency price moves like a zigzag formation; therefore, it shows corrections in the price before moving further towards it. In that market condition, EMA’s especially 20 EMA works well as dynamic support or resistance level. Therefore, any rejection from these levels creates possible trend continuation trading opportunities.
In the image above, we can see a downward market in the EURUSD on the daily timeframe. Price creates a new lower low and is rejected from the static event levels. Moreover, we can see the price also rejects the dynamic level of 20 EMA besides the static levels, which increases the downside possibility. As a result, the price moved downward based on at least 1:2 R: R.
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After the above discussion in EMA vs SMA, we can say that EMA is better than SMA when analyzing the market in a lower timeframe like 5 minutes, 15 minutes, 30 minutes, 1 hour, or 4-hour chart. On the other hand, SMA works well in predicting the trend in higher timeframes like H4, Daily, or weekly.
Therefore, if you are a short-term intraday trader, you can use 100 or 200 SMA to see the overall market condition. Later on, to take any trade, you can use 20 EMA as a dynamic level besides the horizontal support and resistance levels.
On the other hand, there are some demerits of moving averages. As we know, the market moves with its flow, and when we want to anticipate the price with moving averages, we may find it laggy. Therefore, in your trading strategy, you can use other methods besides moving averages to increase the overall probability.
Should you trade with the moving averages on your own at all?
Before you start trading with the EMA or SMA, you'll want to read this.
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