The exponential moving average (EMA) and simple moving average (SMA) are among the most popular indicators used by technical analysts. Both are lagging indicators computed based on different averaging processes that help traders analyze the direction and strength of the prevailing trend.
When comparing the benefits of using an EMA versus an SMA indicator in a forex trading strategy, you may also want to consider the dynamic complexity of the former versus the simple reliability of the latter.
In this article, Benzinga analyzes the technical differences between these two popular moving averages to explain how they can impact forex trading decisions and to help you decide which might suit your currency trading strategy best.
- What is a Simple Moving Average (SMA)?
- Pros of SMA
- Cons of SMA
- See All 13 Items
What is a Simple Moving Average (SMA)?
A simple moving average is a technical indicator used in forex trading that calculates the average exchange rate of a currency pair over a specific period and equally weights each data point in its averaging process. The SMA is a widely used moving average because of its simplicity and ability to provide an accurate representation of market trends.
The calculation of the SMA based on market closes involves taking the sum of the closing exchange rates for a set number of periods and dividing that sum by the number of periods in the calculation. For example, if you want to calculate a 10-period SMA on a daily chart for a particular currency pair, you would add up the closing exchange rates of that pair for the last 10 days and divide the sum by 10.
The SMA is a lagging indicator, which means it can only provide information about past exchange rate movements and not about future trends. It is often used in combination with other technical indicators to provide a more comprehensive analysis of the market.
The SMA is used by forex traders to identify the direction of the trend as well as potential trade entry or exit points. Traders often look for crossovers between the SMA and the exchange rate on a chart as signals to enter or exit trades.
For example, if the faster-moving exchange rate line crosses above the SMA, that is interpreted as a bullish signal, which indicates that the trend may be turning upward. Traders may consider that a signal to buy. Conversely, if the exchange rate crosses below the SMA, it is considered a bearish indication that suggests the trend may be shifting downward. This may be seen as a sell signal.
While the SMA is easy to calculate and provides clear signals, keep in mind that most experienced forex traders will only use the SMA in combination with other technical and fundamental indicators to get a more comprehensive analysis of the market’s direction.
Pros of SMA
Some benefits of using the SMA to trade forex include:
- The SMA is simple to calculate and widely used by traders and analysts.
- The SMA provides a clear directional indication of the market price trend and gives useful potential entry or exit points.
- The indicator helps filter out noise and smooth out exchange rate fluctuations seen over a specified period.
- The SMA can be used in combination with other technical indicators to create a comprehensive trading strategy.
- It is effective in identifying support and resistance levels.
- The SMA can be used in any time frame ranging from short-term to long-term charts.
- An SMA can be adjusted to suit a trader's preferences and trading style.
Cons of SMA
Some cons of using the SMA to trade forex include:
- The SMA is a lagging indicator. This means it can only provide information about past exchange rate movements and not future trends.
- The simplicity of the SMA may result in less accurate readings, especially during periods of high volatility or sudden market movements.
- The use of only one SMA can lead to false signals because it may not capture the complexity of market movements.
- The length of the SMA calculation period may need to be adjusted based on market conditions to avoid false signals.
- The SMA does not account for gaps between periods. This may lead to inaccurate readings in certain circumstances.
- The SMA may not be suitable for all forex traders. Some may prefer more complex indicators that offer a greater degree of accuracy and customization.
- The reliance on the SMA alone may result in missed opportunities or incorrect results if not used in conjunction with other technical analysis indicators like the relative strength index or fundamental analysis.
What is an Exponential Moving Average (EMA)?
Like the SMA, the exponential moving average is another popular technical indicator used in forex trading. Like the SMA, the EMA is a lagging indicator that smooths out market price data to provide a clearer picture of the trend. Unlike the SMA, the EMA is calculated using an averaging process that gives greater weight to more recent data. This makes the EMA more responsive than the SMA to a recent price change.
To calculate the EMA, you can follow these steps:
- Choose the number of periods you want to calculate the EMA for. For example, if you want to calculate the 10-day EMA, you would use the closing exchange rate data from the last 10 days.
- Calculate the weighting multiplier (α) using the following formula:
α = 2 / (N+1)
where N is the number of periods you want to calculate the EMA for.
- Calculate the first EMA value using the SMA for the same number of periods.
- Calculate the current EMA using the following formula:
EMA(t) = (Closing Price(t) - EMA(t-1)) x α + EMA(t-1)
where the EMA(t) is today’s EMA value, Closing Price(t) is today’s closing price and EMA(t-1) is the previous day's EMA value.
The result of these calculation steps is an exponential moving average that places more weight on recent data. This makes the indicator significantly more responsive to current market conditions.
The EMA is often used by forex traders to identify trends, support and resistance levels as well as to generate buy and sell signals. Like SMA, it can be used in combination with other technical indicators to create a comprehensive trading strategy.
Pros of EMA
Here are some pros of using the EMA to trade forex:
- The EMA is more responsive to recent market movements, making it better at identifying trends and potential entry or exit points.
- It can provide clearer signals than the SMA, especially during periods of high volatility or sudden market movements.
- The EMA helps filter out noise and smooth out market fluctuations, making it easier to identify underlying trends.
- It can be used in combination with other technical indicators to create a comprehensive trading strategy.
- It can be computed for any time frame and displayed on short-term and long-term charts.
- The EMA can be adjusted to suit a trader's preferences and trading style.
- It can be used to identify potential support and resistance levels as well as exchange rate crossovers.
- It can be used to generate buy and sell signals based on the crossing of the EMA over the exchange rate or over EMAs with different time periods.
- It can be used to identify potential market reversals based on the divergence or convergence of exchange rate movements and EMAs.
- It can be used to identify potential trend changes based on the direction and slope of the EMA.
Cons of EMA
Here are some cons of using the EMA to trade forex:
- Despite its greater responsiveness, the EMA is still a lagging indicator. This means it can only provide information about past market movements and not about future trends.
- Using the EMA may result in false signals if market conditions suddenly change or if there is a sudden market price movement not reflected in the EMA calculation.
- The use of only one EMA may lead to false signals because it may not capture the complexity of market movements.
- The length of the EMA calculation period may need to be adjusted based on market conditions to avoid false signals.
- The EMA may not work well for all market conditions.
- Traders may need to use different time periods or combinations of EMAs to accurately identify trends and potential trading opportunities.
- Using the EMA alone may result in missed opportunities or incorrect market analysis if not used in conjunction with other technical indicators or fundamental analysis.
- The added complexity of the EMA calculation may make it more difficult for some traders to understand and use effectively.
- Using the EMA may result in less accuracy than more complex indicators or trading strategies that take into account more data and market factors.
Comparing EMA vs. SMA
When it comes to forex trading, both the EMA and the SMA have advantages and disadvantages. A comparison of the two moving averages follows with respect to their speed of response, accuracy and reliability and the best scenarios for using each moving average.
The following exchange rate chart shows an example of a 20-day SMA plotted versus a 20-day EMA plotted over an exchange rate. As you can see, a significant divergence can sometimes develop between two moving averages that have exactly the same time period.
A 20-day SMA plotted in blue compared with a 20-day EMA plotted in orange over a daily candlestick exchange rate chart for the GBP/USD currency pair. Source: MetaTrader5.
Speed of Response
The EMA responds faster to recent market movements than the SMA. This happens because the EMA gives more weight to recent data than older data, while the SMA calculates the average exchange rate observed over a fixed period without giving more weight to recent data.
Accuracy and Reliability
The EMA is generally considered more accurate and reliable than the SMA in trending markets. This is because the EMA places more emphasis on recent data, so it is better at capturing current trends and market price moves than the SMA. This can make the EMA more suitable for short-term traders and swing traders who want an indicator that is more responsive to current market levels and near-term trend shifts.
The SMA is typically thought to be a better indicator than the EMA in markets demonstrating ranging, sideways and volatile price action. This is because the SMA is slower to react to sudden exchange rate movements or changes in market conditions that might trigger the EMA to generate a false signal. This can also make the SMA a better trend indicator for long-term traders looking to capture major market moves without being stopped out of their positions during volatile market conditions.
Keep in mind that the EMA’s quick reactions will sometimes cause a trader to exit a position on a spike while the slower SMA would have kept them in the trade to earn a bigger profit once the market blip has finished. On the other hand, the faster-moving EMA will generally signal trouble with a position sooner than the SMA, so the EMA can get a trader out of the market faster and save them money.
Best Scenarios for Using Each Type
Forex traders can use both the SMA and the EMA to identify potential support and resistance levels and to generate buy or sell signals when it crosses over with the exchange rate. Their choice of moving average may depend on current market conditions and the time frame that they intend to hold a position.
The EMA is typically best used by short-term traders in trending markets because it can more accurately capture the direction and strength of the trend than the SMA. The SMA is probably best used in sideways, range-bound or volatile markets to filter out noise and by long-term traders where it can provide a clearer picture of the market’s underlying trending movement than the EMA, which can tend to overreact to current exchange rate levels.
Using EMA with SMA for Crossover Strategy
Using the EMA with the SMA to create a crossover strategy for forex trading can be an effective way to identify potential entry and exit points based on the crossing of two moving averages. A sample trading strategy is described below that uses both moving average types to generate buy or sell signals based on a comparison with the currency exchange rate and crossings of the two averages.
The initial step in this strategy involves selecting a time period for each moving average. For example, you could use a 20-period SMA and a 10-period EMA. The next step requires identifying the direction of the trend, which can be done by comparing the current exchange rate with the moving averages.
If the rate is higher than both averages, that could indicate a bullish trend. If the exchange rate was situated under both moving averages, then it would signal a bearish trend.
Now you just wait for a crossover to occur between the two moving averages. A bullish crossover occurs when the EMA crosses above the SMA, while a bearish crossover occurs when the EMA crosses below the SMA.
Once you detect a crossover, you can enter a trade in the direction of the trend. For example, if a bullish crossover occurs in an uptrend, this would signal the time is right to enter a long position. Conversely, if a bearish crossover occurs in a downtrend, you could enter a short position.
Ideally, you want to enter a stop-loss order to limit your risk to an acceptable level and a take-profit order to lock in potential profits. One way to set a stop-loss order would be below the recent low when taking a long position or above the recent high when taking a short position. You can set your take-profit level based on your chosen risk-to-reward ratio for the trade, ideally just ahead of a chart point that might prevent the market from reaching your order.
Keep in mind when using a strategy like this that moving averages are lagging indicators, so they may not accurately capture sudden market movements or changes in trading conditions. Also, you will generally want to use prudent risk- and money-management techniques when trading currencies. You should also consider combining an EMA and SMA crossover strategy with other technical indicators and fundamental analysis to create a more comprehensive approach to trading forex.
What Type of Moving Average Should You Use?
In general, if you are a forex trader who wants to capture trends accurately and have a more responsive moving average to current market levels, you should consider using an EMA. An EMA is particularly suitable for short-term currency traders who prefer to operate in trending markets and who want to enter or exit a trade quickly based on recent market movements.
On the other hand, if you are a forex trader who wants to filter out market noise to get a clearer picture of the underlying exchange rate movements, you should probably use an SMA. An SMA is particularly suitable for forex traders who prefer to trade in sideways or range-bound markets and who want to enter or exit a trade based on the long-term trend in a currency pair.
Because both EMAs and SMAs have their advantages and disadvantages, you might prefer to use a combination of both moving averages depending on your trading style and current market conditions.
Frequently Asked Questions
Which is better: SMA or EMA?
It depends on your trading style, preference and market conditions. The SMA is considered better for traders who want to filter out noise and have a clearer picture of the underlying market movements, while the EMA is thought to be better for traders who want to capture trends and have a more responsive moving average.
Should I use 200 EMA or SMA?
The choice between using the 200 EMA or SMA depends on your trading preferences and strategy. The 200 EMA is going to be more responsive, so it tends to suit traders wanting to capture trends and enter or exit trades faster based on recent market moves. The 200 SMA moves more slowly, so it can help filter out market noise and typically is better suited to traders looking to identify long-term trends.
Is the EMA or SMA better for swing trading?
Swing traders typically want to use the EMA over the SMA because they need to determine the overall trend direction as well as use a more responsive moving average that will give them signals to enter or exit trades quickly based on recent market movements.