Maybe you think that the Moving Average (MA) is just a collection of colored lines on the chart.
However, moving averages have various functions as a good indicator for your trading strategy.
MA is a simple indicator that is relatively easy to apply when trading/investing.
Therefore this indicator is widely used by traders.
Moving averages are trend-following and lagging indicators because they are based on what has happened.
The moving average is calculated based on the average value of price movements in a certain period.
Based on the average value, it can be taken from the highest, lowest price, opening price, closing price, or median price.
The longer the period used in calculating the Moving Average indicator, the slower the movement (lagging) compared to the price.
Moving averages with shorter periods will be more “responsive” than moving averages with higher periods.
The moving average itself is divided into several more types, and there are two types of moving averages.
The two most commonly used moving average types are the Simple Moving Average (SMA) and the Exponential Moving Average (EMA).
These two indicators are the development of the Moving Average (MA).
The difference is in the formula or calculation method that affects the level of sensitivity to price movements.
Which is the best between SMA and EMA? This is a question that traders, especially novice traders, ask quite a lot.
Moving Average Cycle
As explained above, the Moving Average clarifies the direction of the chart, the level of “smooth” depends on the “period” of the Moving Average.
Take a look at the chart above; you will see that the MA 10 will be more responsive to price movements that occur, while the MA 20 looks more “smooth” and much more.
The longer the period, the more closing prices are included in the calculation of the Moving Average, meaning that individual price points do not influence the Moving Average.
If the period is too long, the Moving Average will become too “smooth,” and you will not be able to detect any trend.
And if the shorter the period, the less the number of closing prices included in the average calculation, the Moving Average will be closer to the price.
What Is Simple Moving Average And Exponential Moving Average?
How to use all moving averages is quite similar.
It’s just that what distinguishes them from all types of moving averages is that the average calculation that weighs a specific period value is considered more weighty.
For example, if the Simple Moving Average only uses an ordinary average, the Exponential MovingAverage will use a weighting system, so different average values are obtained from this weighting.
The difference between Moving Average types is the sensitivity level given by each of these indicators to price assets.
There are many more types than the Moving Average, but we will focus on the Simple Moving Average (SMA) and Exponential Moving Average (EMA).
Simple Moving Average (SMA)
The simple moving average is one of the most widely used indicators by traders in their trading.
But even though SMA is a simple indicator, SMA has a good ability if it is accompanied by proper use because it can lead you to recognize price movements well.
Where analyzing price movements is something that every trader must do when entering the market.
So what is the correct calculation using this one indicator?
Try to pay attention to the illustration below to make it easier to understand.
“If you use the 50 SMA on the 1-hour time frame, the 50 SMA you see is the result of adding up the last 50 closing prices, then dividing that to make it easier to understand the sum by 50. Then you will have the average closing price for the last 50 hours..”
SMA formula according to the picture below:
The formula above is the same as the Moving Average calculation method.
You also don’t have to worry about calculating SMA correctly; we are in an era where everything is completely automated because almost all trading platforms that you can use must provide this indicator.
With this simple calculation, you already have a solid foundation if you want to modify this Simple Moving Average according to your strategy.
Exponential Moving Average (EMA)
The exponential Moving Average derivative of the Simple Moving Average technical indicator.
Although the EMA calculation is not as simple as SMA, the EMA calculation can be said to be more profound because it is weighted more to the close price in a certain period.
The effect is that the EMA tends to be more sensitive to price movements, so the EMA moves a little more aggressively than the SMA.
It will cause differences in determining the Golden Cross or Death Cross.
If the difference between EMA 5 and EMA 20 is very close.
If the close price rises significantly in the morning, the asset can be said to have entered the Golden Cross phase, but if the close price suddenly drops very profoundly during the day, then the Golden Cross phase does not form.
The EMA is usually used with other indicators to confirm significant market moves and measure their validity (in combination with Stochastic for Money Magnet).
The EMA is more applicable for traders who trade intraday and fast-moving markets.
Quite often, traders use the EMA to determine trading bias. For example, if the EMA on the daily chart shows a strong upward trend, the intraday trader’s strategy may be to only trade.
EMA formula :
Look at the picture above.
You can see the difference between the two types of Moving Averages in the same period.
SMA is further away from the price, and EMA is trying to get close to the price where EMA is more sensitive than SMA.
Pros and Cons Between Simple Moving Average And Exponential Moving Average
Each type of moving average has its pros and cons.
Below is a table to help you remember the pros and cons of SMA and EMA.
From the pros and cons above, you can better know which one is better to use when trading from the pros and cons above.
How To Trade With SMA or EMA
The application of the two MAs is relatively easy and very similar actually.
There are various ways to use both in trading, but here are the two most common ones you can use when trading.
As A Buy/Sell Signal Indicator
If you are a scalper, then this strategy is beneficial for you to make a profit in the market:
- Wait for the short EMA/SMA (choose one) until it cuts the long EMA/SMA upwards
- Wait for other confirmations, such as a breakout level lock
- Your Stop loss is higher or lower than the consolidation zone below your entry point
- Follow the MA direction
- Close your position when a short EMA/SMA will cross the long EMA downwards
As you see in the picture above, the 13 periods EMA is in yellow and the 21 EMA in blue on the 5-minute time-frame chart for the USD/CAD currency pair from April 11 to April 12, 2022.
The currency pair increases when the yellow EMA line crosses the blue EMA line above.
For example, you buy a long position at 1.26039 with a stop loss at 1.25956.
Then you wait for the yellow EMA to cross the blue EMA and close the order at 1.26295.
Vice versa, if the yellow line (Short EMA) crosses the blue line (long EMA0 downwards, then this is a signal for you to open a sell order position.
It would be best to close the position when the short EMA crosses the long EMA upwards.
On the same chart (USD/CAD), the cut of the two EMAs on April 13 to 14 helped you open short positions at 1.26351 with a stop loss of 1.26655.
Then, you have to wait for another cut and close your position to the support at 1.25634.
The time difference between an open position and taking profit is only 6 hours.
The Indicator Functions As Dynamic Support And Resistance
You can use EMA and SMA to set resistance or support levels in some situations.
Looking again at the chart for the USD/CAD pair, you can see that the price was able to find support and resistance around the 10-period
EMA always moves up and down following the price action. EMA can be beneficial, but it can also fool you.
Therefore, it is better for you to follow price action, not randomly place support and resistance around the EMA area.
Identifying The Moving Average Price Trend
To determine the direction of the stock price trend, you can see the Moving Average positioned against the current price, whether the price is below the MA or above the MA.
If the price is below the MA, you can choose a sell option because the trend is showing Bearish or decreasing, but if the price is above the MA, you can choose a buy option because the price is showing at that time Bullish or increasing.
There are conditions where the price is not above or below the MA, and the price only moves in the middle of this situation, called sideways.
In conditions like this, you can choose to take a trading break first and wait for the next trend to occur.
Simple Moving Average Vs. Exponential Moving Average: Which Is The Best One?
SMA and EMA show a striking difference, but it does not mean one is superior to the other.
It depends on the trader’s style of analysis, goals, and time horizon.
Every asset has its frequency. Sometimes, the SMA reacts better, and sometimes the EMA does.
The longer the period, the slower the moving average reacts to price movements.
SMA is most useful for long-term trading, while EMA is more beneficial where there is short-term price movement.
The same features that make the EMA a better choice for short-term trading make it less effective for long-term trading.
If you are a reliable scalper, the EMA is the right choice.
The EMA will move faster than the SMA, often making sudden changes in price direction.
Therefore, price spikes can send the wrong signal about the emerging trend.
With a slower lag, SMA tends to smooth price action over time.
This makes it a good trend indicator, as it stays short when the price is below the SMA and extended when the price is above it.
The SMA will give you an overview of the trend-making it easier to identify fakes.
Traders need to try different strategies and backtest the charts to see which yields more returns with all types of moving averages 10, 5, 20, 50, 200 SMA, and 200 EMA.
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