T
he two most commonly used types of moving averages are simple and exponential ones.
What do we know until now?
- The simple average has no weighting – all prices are treated equally when calculating the average.
- The exponential moving average of the newer values has more weight in the calculation.
But which one is better?
Let’s go with the exponential moving average first.
One of the advantages of using exponential averages is:
Exponential moving averages try to reduce the lag by focusing more on the latest data, assuming that newer data is a more appropriate basis for predicting what may happen in the future.
However, there is a possibility not to smooth out the price fluctuations.
If you want to get a quick response to the price action, you use a short period EMA, in order to help you catch trends very early.
In other words, the earlier you understand that our lessons are very important for your trading strategy, the longer time you will have to enjoy your successful trades without losing money.
Meaning that the earlier you catch a trend, the longer you can take benefit of this trend and make profits.
The disadvantage of using exponential moving average is:
During consolidation periods you might be misled that a new trend is forming, when it is just a price spike, because of the quick MAs response to the change of price.
Let’s look at the simple moving average.
The simple moving average is smoother and it slowly responds to price action.
That’s why it is best to use a longer period of SMA.
This way you can see the overall trend.
Advantage of SMA – it could possibly save you from many fake-outs.
The disadvantage of SMA – it might have bigger delays and you could miss the point where it is a good time for an entry.
Simple vs. Exponential Moving Average
Let’s make a clear differentiation:
Using SMA will result in a smooth chart that eliminates most fakeouts.
BUT it responds slowly to the change of price and because of this lag in selling and buying signals, you might miss out on getting in on the trend early.
On the other hand, EMA is quickly moving and responding to the price changes, so you can catch the beginning of the trend.
BUT EMA tends to cause fake-outs, giving the wrong signals.
In conclusion, EMA will track the price more closely than an SMA. That’s why you need to use it mainly for short-term trading.
When you use it for a longer timeframe, it can limit you from getting good entry and exit points on a slower chart ( for example a daily one).
The SMA is smoother over long time periods and it will show you to remain long when the price is above the SMA and go short when the price is below the SMA.
Like you see it is all up to you and what kind of trader you are.
Different loves for different doves.
You don’t need to choose only one single type of MA, cause you can plot several different ones, in order to see both the bigger picture( the overall trend) and the trends right at this moment to decide when to enter.
However, don’t let yourself to get confused, because the more MAs there are on a chart, the harder it becomes to determine which ones are more relevant!!
Take it easy! When you start experimenting with different periods, you will see which one works out for you the best.
