Types of Moving Averages - SMA, EMA, LWMA and SMMA
There are 4 types of moving averages:
- Linear weighted
The difference between these 4 is the weight assigned in to the most recent price data.
Simple Moving Average - SMA
SMA applies equal weight to the data used to calculate the average and is calculated by summing up the price periods of a financial instrument and this value is then divided by the number of such periods. For example simple moving average 10, adds the data for the last 10 periods and divides them by 10.
Exponential Moving Average - EMA
EMA apply more weight to the most recent price data and is calculated by assigning the latest price values more weight based on a percent P, multiplier that is used to multiply and assign more weight to the latest data.
Linear Weighted Moving Average - LWMA
LWMA averages apply more weight to the most recent price data and the latest data is of more value than earlier data. Weighted moving average is calculated by multiplying each of the closing prices within the series, by a certain weight coefficient.
Smoothed Moving Average - SMMA
SMMA is calculated by applying a smoothing factor of N, the smoothing factor is composed of N smoothing periods.
The example below shows SMA, EMA and LWMA. The SMMA is not commonly used so it is not shown below.
The LWMA reacts fastest to price data, followed by the EMA and then the SMA.
SMA, LWMA, EMA
Day Trading with Exponential and Simple Moving Averages
The SMA and EMA are the most commonly used. Whereas the EMA has a more sophisticated method of calculation, its more popular than the SMA.
Simple Moving Average is the arithmetic mean of the closing prices in the period based on the set time period where each time period is added and then it is divided by the number of time periods chosen. If 10 is the period used the price for the last ten periods added up then it is divided by 10.
SMA is the result of a simple arithmetic average. Very simple and some Forex traders tend to associate with the Forex trend since it closely follows price action.
EMA on the other hand uses an acceleration factor and it is more responsive to the trend.
The SMA is used in currency charts to analyze price action. If the price action in more than 3 or 4 time periods show below the SMA then its an indication that long trades should be closed immediately and the bullish momentum is waning.
The shorter the SMA period the faster it is to respond to price change. SMA can be used to show direct information regarding the trend of the market and the strength by looking at its slope, the steeper or more pronounced slope display is, the stronger the Forex trend.
The Exponential Moving Average is also used by many traders in the same way but it reacts faster to the market moves and therefore it is more preferred by some traders.
The SMA and EMA can also be used to generate entry and exit points. These Moving averages can also be combined with Fibonacci and ADX indicator to generate confirmation signals.