Exponential Moving Average (EMA) vs Simple Moving Average (SMA)

13 April 2021

    Moving Averages

     

    One of the most popular categories of indicators in trading are moving averages. Moving averages are a series of averages displayed on the chart, which are calculated using a specified subset of the data e.g. a set amount of periods configured by the user. Moving averages are used for market states by smoothing out the price movement over a certain period of time. There are several types of moving averages, with each one having its own advantages and disadvantages. In this article we will deal with the two most popular ones - exponential moving average and simple moving average.

     

    What is EMA

     

    The exponential moving average indicator, also known as EMA, is a technical chart indicator that tracks the price movement of an instrument over time. It is a type of a moving average indicator, and one of the most popular trading indicators, used by thousands of traders. The EMA indicator is a weighted moving average indicator and it gives more importance to recent price data, when compared to a simple moving average. Because of its unique calculation, the EMA indicator will follow prices more closely than a typical simple moving average.

     

    How Does EMA Work

     

    The ema indicator averages the past prices of an instrument, but uses a weighting approach to emphasize more on the recent price action rather than the past price activity. In contrast to a simple moving average, where all prices are treated equally, recent price changes play a much larger role in the calculation of the exponential moving average results compared to older data. Exponential moving averages are used to identify trends and reversals, as well as to outline important support and resistance levels.

     

    To add an exponential moving average indicator in Fondex cTrader, follow the steps below:

     

    1. Right-click on the chart and navigate to Indicators > Exponential Moving Average 
    2. Click on the Exponential Moving Average indicator and the following will pop up.
    3.  Select Source, Periods and Shift and click OK. The indicator will be plotted on your chart. 

     

    Calculation

     

    The formula to calculate an exponential moving average is pretty straightforward. We can see the equation used for the calculation of the EMA indicator below

     

    EMA = Price(n) * k + EMA((n - 1) * (1 - k)

     

    Where

     

    EMA = Current value of the exponential moving average indicator

    n = Current bar

    k = 2 / (Periods + 1)

     

    What is SMA

     

    Simple Moving Average (SMA) is the simplest form of a moving average. In contrast to the EMA indicator, the SMA indicator does not apply any weighting to price data. In the SMA indicator, all data has the same weight and is considered in the same way during the calculation.

     

    How Does SMA Work

     

    As with any moving average technique, an SMA indicator averages the past prices of an instrument, but does not apply any type of weighting. Compared to the exponential moving average, all data is treated equally, regardless of its time dimension. SMA indicators are mostly used to identify the current state of the market, trending or ranging.

     

    To add a simple moving average indicator in Fondex cTrader, follow the steps below:

     

    1. Right-click on the chart and navigate to Indicators > Simple Moving Average 
    2. Click on the Simple Moving Average indicator and the following will pop up
    3. Select Source, Periods and Shift and click OK. The indicator will be plotted on your chart

     

    Calculation

     

    The formula to calculate a simple moving average is pretty straight forward. We can see the equation used for the calculation of the SMA indicator below

     

    SMA = (Price(n)  + Price(n-1) … +Price(n+k)) / k

     

    Where

     

    SMA = Current value of the SMA indicator

    n = Current bar

    k = Periods

     

    Simple Moving Average vs Exponential Moving Average

     

    Even though the two moving averages share the same concept, that of smoothing the price movement, they are used in different ways. The Exponential moving average, being a more reactive indicator, is usually used for detecting changes in the direction of the price and it is used a lot in strategies to indicate good entry points. Some examples of such strategies are the EMA Golden Cross and the EMA Death Cross, EMA Ribbons and the Three EMA Crossover Strategy. SMA indicators, on the other hand, are used to identify a more broad market state and are good for highlighting support and resistance points. They are also widely used in exit strategies.

     

    Limitations of Moving Averages

     

    SMA indicators and EMA indicators, just like any other technical indicators, need to be used in context. MA indicators can generate a lot of false signals that could lead to substantial losses if used out of context. Therefore, when using MA indicator strategies, always consider the market fundamentals that currently move the market and combine the signals with other confirmation signals, like oscillators, support/resistance levels and the relevant price action taking place on the chart.

     


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