Introduction
Moving average is a very popular indicator used in technical analysis. It is considered as a lagging indicator due to the nature of it using previous price action to provide an average price even when there are large short-term price fluctuations. There are two types of moving average indicators: SMA (simple moving average) and EMA (exponential moving average). Both of which are used often to confirm market trends.
Simple Moving Average (SMA)
SMA is a technical indicator used by professional traders. It is calculated by adding up closing prices from a period and divided by the duration of the period. Hence traders usually describe their moving average settings as some duration e.g. 50 day SMA, 100 day SMA.
-Orange is 50 day SMA setting
-Green is 100 day SMA setting
-Blue is 200 day SMA setting
The most common and simple usage of SMA is finding price trends. Due to it being averaged out over a duration, volatility is smoothed out which allow price trend to be more accessible. Using the graph above, we see that the 50 day SMA giving a bearish price action, this is backed up by the 100 day SMA flattening out as it begins its downward price action. Another way SMA is used as a technical tool is the pattern called the death cross and golden cross. Death cross is a pattern in which a lower duration SMA cross downwards towards a higher duration SMA, this gives a bearish confirmation for future price action. While golden cross is the 50 day SMA crossing with the 200 day SMA, which can be seen on the chart above at the start of 2019 which gives it a bullish future price action.
Exponential Moving Average (EMA)
Similar to the SMA, EMA is a technical indicator that is calculated by the average of closing prices over a time frame. However, EMA places a larger emphasis on recent price action and give it more weighting. For EMA, most traders use 20 day, 30 day, 90 day and 200 day settings, where 20 and 30 day EMA are for short term analysis while 90 and 200 day are used for long term trends.
Exponential Moving Average on daily EUR/USD chart
-Orange is 20 day EMA setting
-Blue is 90 day EMA setting
-Yellow is 200 day EMA setting
The usage of EMA is similar to SMA however the difference is that EMA “hugs” the price action a lot more due to the higher weighting on the most recent price action. This provides a more accurate representation of recent price movements. From the chart above it can be seen that the 20 day, 90 day and 200 day EMA portrays bearish price action.
By Peter Chieng