In a longer term the trend usually lasts for a prolonged period of time, which makes the immediate recognition not so important. In the mean time, however, the market may continue its prior move in the direction of traders position.įor a trader who uses longer time frames the SMA will probably be a better choice, because of its smoothness. As the EMA reacts faster to most recent price action, it could signal that the trend has already reversed and that the trader should exit his/her trade, probably at a loss. A negative side in this case can be the probability to be stopped out (traders stop-loss could be triggered), if a fakeout or unusual spikes and splashes occur. With the EMA he/she will be able to recognize and enter the trend earlier, than if using the SMA. Thus, the SMA better smooths out fakeouts and extraordinary price movement.įor a trader who uses smaller time frames and is willing to catch the trend fast, the EMA will be a more appropriate choice. The EMA has greater agility and usually reacts faster to changes in general market sentiment and respectively price action, while the SMA reacts in a slower manner. This also explains why a number of oscillators use an EMA and most particularly the MACD, which we shall discuss next. So, we can say, that the EMA better reflects what market players are doing now than the SMA. Notice that during the first 12 days (the 12 consecutive green candles to the left) the EMA remains above the SMA and then reacts earlier to the change in sentiment (the 8 consecutive red candles). Therefore, the EMA reflects most recent sentiment more distinctly. That is because the AUD/USD pair demonstrates a clear downward movement during these most recent four days. The graph shows that during the most recent 4 periods (days) the EMA moves below the SMA. Usually the EMA will change its direction more rapidly than the SMA, because of the additional weighting it places on the most recent data. Here we can see a 10-day SMA (the black line) and a 10-day EMA (the blue line). Thus, we begin constructing the table in a bottom up manner. Beginner traders should take note, that the EMA (i-1) value for the 10th day (which in our case is the earliest period) is the closing price of candle number 11, which stands before the ten successive closing prices in the table, or 0.89450. In the table above we used exactly the same closing prices and the same candles as when calculating the SMA in the previous article. SF = 2/(n+1), where n represents the number of periods the EMA uses. SF refers to a smoothing factor, which is calculated as follows P (i) refers to the price in period (i), which is most often the closing price ĮMA (i) refers to the most recent value of the EMA ĮMA (i-1) refers to the previous recent value of the EMA It can be calculated by using the following formula:ĮMA (i) = EMA (i-1) + SF*, where In this case a technical analyst uses the Exponential Moving Average (EMA). However, this effect can be smoothed out by using a different way of data averaging. As it is a short-term SMA, its value can change only due to some extraordinary price action during one single day. Tables above show how equally-weighted data influence the overall value of the SMA. We can see that the value of the 10-day SMA has decreased, because of a change in data regarding only a single day. What will be the influence upon the value of the SMA? Trading Day Let us assume that on the 9th day AUD/USD pair closed not at 0.89257, but at a lower level, say 0.88488, because of a disappointing retail sales report released out of Australia. We have estimated that a 10-day SMA has a value of 0.8921. Let us look again at the example we provide in the previous article. How to calculate an Exponential Moving Average? Most recent data is given greater relevance (greater weight), while earliest data is given less weight. On the other hand, an EMA gives different weights depending on the recentness of data. When calculating a SMA for a certain number of days, each day is given equal importance, equal weight, which means that each days data will have an equal impact upon the value of the simple moving average.
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