Moving averages come in two different forms, the simple moving average and the exponential moving average. Both are important to successful trading, and both should be understood by the traders who use them. It is vital to know the differences between the two if you want to know how to use them well. Let’s explore what each means and why it is important to your trading abilities.
Exponential Moving Average (EMA)
What is happening right now in the markets? The traders who want to see how the latest price action has had an impact on various currency pairs rely more heavily on the EMA to do their trading. They like to use this because it incorporates the real-time numbers as they come in more rapidly than any of the other moving averages. You see, when someone uses the EMA, they are saying that they want to see how each tick of the currency pair has a direct impact on the average price that they see for that currency pair over time.
It is easy to get a lot of good information out of this indicator, but you should also know that it can produce some false readings if you examine it too closely. Since the EMA tracks so closely to the current price of the currency pair, it can sometimes appear that certain things are happening in the market that are not actually happening. Always be aware of how this indicator reacts to current news.
Exponential Moving Average Pros: Moves quickly and good for displaying recent price swings
Exponential Moving Average Cons: Can be more likely to cause fakeouts or erroneous signals
Simple Moving Average (SMA)
This is the type of moving average that traders are first introduced to when they begin trading in the markets. This is because it is literally the simpler of the two to understand. It just takes the data from the past and incorporates it into an average that you can see drawn on your chart. You can set it to trace back however far you would like, but it is going to just tabulate the average over that period of time and produce that number for you. There is nothing magical about the SMA except for the fact that it is useful when compared against the EMA and other indicators.
The simple moving average is probably best used as a baseline against which to compare other indicators. Its value comes from the fact that when traders use it they are able to see how the currency pairs that they care about are trending in one direction or another. The purpose is to simply provide traders with something that they can base their trades on in terms of how they believe the market is likely to trend. If they feel that the market is headed up and the simple moving average is also pointed in that direction, then perhaps they have a little more confidence in their prediction than they otherwise would have. That said, it is obviously still a good idea to try to compare where the market is now versus where it has been in the past by using all available data including the simple moving average and many other indicators.
Simple Moving Average Pros: Shows a smoother chart with fewer fakeouts
Simple Moving Average Cons: Moves slowly, which leads to a lag in buy/sell signals
Do not rely solely on any one of these tools to act alone, but compare the various options that are available to you, and see for yourself where you should place your trades based on that information. It is great when you can use the EMA and the SMA in tandem and when they indicate that the market is moving in the direction that you believed it would. If that is the case, then you can take advantage of your predictions and place your trades according to your hypothesis.