Types of moving averages (SMA, EMA, WMA)
The moving average is one of the oldest technical indicators and, perhaps, the most popular and most frequently used, because on its basis a huge number of other indicators are built. Moving averages are used as the main indicator of trend movement and indicating its direction (up, down). Their main properties are smoothing out local market noise and determining the main market trend.
In simple words - it is important to remember that for example a moving average with a period of 8 displays the average value of the price for the last 8 candles.
There are 3 types of moving averages:
- Simple moving average, (SMA)
- Exponential moving average (EMA)
- Weighted moving average (WMA)
By default, the term "moving average" means a simple moving average.
Let’s remind that the MAs average the data on the price, thereby allowing the analyst to see hidden trends. In a sense, the moving averages slow the price movement on the chart. Moving averages "slip" along the chart with the price.
➡️ Simple moving average
A simple moving average of period n at the moment k is the arithmetic mean of n values from k-n + 1 to k. In other words, the 5-day moving average for today is calculated by adding five previous prices (i.e. today's plus four past ones) and dividing them by 5. I.e. if the prices were such: 9, 8, 8, 9, 10, then the simple moving average will be (9 + 8 + 8 + 9 + 10) / 5 = 8.8. Therefore, at today's price of 10, the moving average will be 8.8.
For tomorrow, we will have to calculate the new value of the moving average again, and use the fresh data to calculate it: 8, 8, 9, 10, 11 (where 11 is the price of tomorrow, note that we missed the first nine, but in the end we added the most recent price). Therefore, tomorrow's moving average will be (8 + 8 + 9 + 10 + 11) / 5 = 9.2
➡️When calculating the exponential moving average, earlier prices are of less important, and later prices are of more important.
➡️ Weighted moving average
A weighted moving average, like an exponential one, also adds more "weight" to later data, but it makes it simpler. When calculating the 5-day weighted moving average, we give the current price five times the weight, yesterday's - four times, the day before yesterday - three times, etc., and then divide the sum of all the operations by the amount of added weight.
The calculation formula is simple: every price that is included in the weighted moving average calculation must be multiplied by its serial number, and then divided by the sum of the serial numbers. I.e. (1 · 8 + 2 · 8 + 3 · 9 + 4 · 10 + 5 · 11) / (1 + 2 + 3 + 4 + 5) = 146/15 = 9.73.
? Comparison of Moving Average Types
The difference between the three types of moving averages for an analyst is, by and large, small. But, nevertheless, there are differences between the types of moving averages and they are quite noticeable.
The practice of leading traders shows that:
- EMA is the most effective for short periods;
- for longer-term time intervals, a simple SMA is the best.
It is also believed that the simple average moving - the most "lazy", exponential - the most dynamic. What kind of moving averages to use in technical analysis is solely the matter of the analyst.
When using this technical indicator trader should remember that:
- the longer the moving average period, the less sensitive it will be to price changes
- a moving average with a very short period will generate a large number of false signals
- the moving average with a very long period will be constantly lagging behind
- when it’s the lateral trend, it is necessary to apply moving averages with a long period.
In classic books on trading, the concept of "intersection" is most often considered - when a fast moving average, for example, 8, crossed a slower one, for example 21, this means buying.
Conversely, a fast moving average crossed a slow one from top to bottom - for example, the 8th moving average crossed the 21st moving average. This is a signal to sell.
In general, it is believed that such an approach is unreliable, because when the lines intersect, it is often too late to buy or sell, as they follow the price and are late, in other words, give a signal when the trend has already lost its original strength.
The intersection of moving averages can be used by us as an additional filter for making decisions about the current trend.