What is Simple Moving Average (SMA)?
A simple, or arithmetic explanation of moving average is that moving average is calculated by adding the closing/opening/average price of the currency/shares for a number of time periods and then dividing this total by the number of time periods. Short-term moving averages respond quickly to changes in the price of the underlying, while long-term moving averages are slow to react.
In simple English, the weightage given to past period is the same as the current time period. The curve of the moving average tends to act as a support/resistance to the price. In other words, the longer the period use to calculate the moving average, the stronger the levels will at the moving average. It is important to note that when "moving average" is mentioned, it generally refers to the SMA.
What is Exponential Moving Average (EMA)?
The EMA is a type of moving average that is similar to a simple moving average, with the exception that weightage is applied to the different time period. The latest time period is given a higher weightage while the earliest time period is given a lower weightage. The EMA is also known as the "exponentially weighted moving average".
EMA reacts much faster to the recent price changes than the SMA. The 12- and 26-days EMAs are the most popular type of short-term averages used. They are often used to create indicators, for example the moving average convergence divergence (MACD) mentioned in an earlier post. The 50- and 200-days EMAs are generally used as trend signals for long-term trending.
In summary, the best way to make use of moving averages is to plot different types of moving averages on a chart so that you can see both short term and long term movement of the currency/stock. Once the short/long term trend of the chart is determine, you can trade with better ease.
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