Moving Average has four main types: SMA, EMA, SMMA, and LWMA. By optimizing the parameters of each Moving Average, traders can identify price trends, reversals, and support and resistance.
Moving Averages (MA) are indicators that traders must master because they cover technical matters in trading. Behind its convenience, MA turns out to have various types. In this article, we will talk about Moving Averages and the four main types that traders use when trading the forex market.
Moving Average Overview
Moving Average or usually abbreviated as MA is one of the technical analysis indicators popularly used by traders as a guide to the price trend. Moving Averages are used to see the momentum of the price movement while ascertaining the existing trend and determining support and resistance areas.
The data used is historical so Moving Average becomes a lagging indicator that analyzes, not predicts. It is a simple technical analysis to confirm bearish, bullish, or sideways trends.
What Are the Major Types of Moving Averages?
Moving Averages were developed to smooth out market noise and show market trends more clearly. Over the years, Moving Averages have branched out into several different types. The four major Moving Averages that are most widely used are as follows:
Simple Moving Average (SMA)
It can be said that Simple Moving Average (SMA) is the simplest technical analysis tool for traders. This tool filters market price fluctuations by averaging price values in the calculated period. For example, to get the latest price of SMA calculated over a certain number (N) of periods, all the prices of the N periods are added together, and then the amount is divided by N.
The value of the Simple Moving Average (SMA) is generated by the following formula:
SMA = (PRICEi + PRICEi-1 +......+ PRICEi-N+1) / N
PRICE is the closing price for each period participating in the calculation. And N is the number of periods, during which the indicator is calculated.
Exponential Moving Average (EMA)
An EMA is a type of Moving Average that predicts the direction of a trend in a certain period by giving more weight to the current price movement than in the past. In other words, EMA is more aggressive with the momentum of the latest price change than SMA.
To calculate EMA, several steps need to be considered. First, the Simple Moving Average needs to be calculated, then followed by the digger to weigh the EMA, and the last is to calculate the EMA of this period by taking the period from the initial EMA to the latest period, using the price, multiplier, and EMA value of the previous period.
The formulation of EMA is as follows:
EMA= α x [Ptoday– EMAyesterday] + EMAyesterday
Where α is a smoothing constant (part of the price value) whose calculation is fixed α = 2/(1+N) with N as the unit number of the period. EMAYesterdayis a simple Moving Average value of the previous period. And Ptoday is the price value at today's close or N+1.
Smoothed Moving Average (SMMA)
SMMA (Smoothed Moving Average) is one of the widely used technical analysis tools to determine areas of support and resistance and market trends more clearly. SMMA makes sure to filter out price fluctuations (noise) by averaging the price value of the period. For the calculation process, it is almost the same as the EMA which adds weight values to the average price. The difference is that the oldest price data is never added while a new price is added to the calculation.
The SMMA value is calculated using the following formula:
SMMA = [SMMAi-1 (N-1) + PRICEi] / N
Where: PRICE is the current price value, SMMA(i-1) is the previous value, and N is the number of unit periods.
When the price rises beyond SMMA. This indicates that there is a bullish occurrence on the trading instrument. On the contrary, when the price falls lower, it shows a bearish condition. In addition to that, SMMA provides a broader view by 'smoothing' short-term fluctuations. This additional accuracy helps traders confirm market trends that have developed.
Linear Weighted Moving Average (LWMA)
LWMA (Linear Weighted Moving Average) is one of the most popular and widely used indicators. It is arguably a development of the Simple Moving Average, but its main drawback is its substantial lag behind the market price and the double impact of the same price on the calculation of the indicator. Both indicators smooth out the market noise and show the market trend more clearly.
To achieve the goal, the indicator filters out market fluctuations (noise) by averaging the price values of the period. However, in LWMA's case, some of the latest prices have the highest weights (weights) added to the average calculation and the weights will decrease linearly for each previous price. This process is used to calculate all the price values of the indicator so that it can be ascertained that the LMWA has an aggressive response to price changes compared to SMA.
LWMA is calculated by the following formula:
LWMA = [(Pn W1) + (Pn-1 W2) + (Pn-2 W3) +......] / ∑W
Where:
P = Price for the period, n = The most recent period, n-1 is the prior period, n-2 is two periods prior, and W is Weight for each period starting from the order of the highest weight, especially from the number of periods used.
What If They're All Compared in One Chart?
The Moving Average indicators have only one parameter, which is the number of periods. Possible values are from 2 to 10,000. The smaller the number, the fewer market noises the indicator filters, and the faster it reacts to changes in market prices. The line stays closer to the price bar, thus, following the short-term market trend and resulting in less lagging.
On the other hand, the larger the number of MA periods, the more market sounds are filtered by the indicator, and the slower it reacts to price changes. The line is farther from the market price bar, thus, following the long-term market trend and resulting in a more significant lag behind the market price.
See Also:Leading Vs Lagging Indicators in Forex Trading
To see the difference between the four major Moving Average indicators, you can distinguish it from the example price chart below. This figure shows a price chart with 4 MA variants; all of them use a period of 12.
The picture shows that Simple Moving Average experiences slight fluctuations that can give you wrong signals. The Smoothed Moving Average shows a smoother grinding than others. As for the Exponential Moving Average (EMA) and Linear Weighted Moving Average (LWMA), they have similar movements. The difference is that LWMA moves more toward the price while EMA is more responsive to the latest market price.
See Also:3 Reasons Why 200 EMA is Important for Your Analysis
Other Types of Moving Averages
- Adaptive Moving Average (AMA): has low responsiveness to noise and minimal lag when determining trend reversals and changes. This MA does not fluctuate strongly when the price matches the increase so as not to cause the wrong trading signal.
- Double Exponential Moving Average (DEMA): smoothes out the price or value of other indicators. When the price moves in a zigzag fashion, DEMA will not produce false signals. This sustains position maintenance during periods of strong trends and reduces signal lag compared to regular EMAs.
- Triple Exponential Moving Average (TEMA): Synthesis of single, double, and triple EMA. The total lag is much less than for each of those MAs separately.
- Fractal Adaptive Moving Average (FRAMA): the smoothing factor is calculated based on the fractal dimensions of the current price. The advantage of the indicator is that it follows a strong trend and slows down drastically during the consolidation period.
- Variable Index Dynamic Average (VIDYA): This EMA has an average period that changes depending on market volatility. Market volatility is measured by Chande Momentum Oscillator (CMO) whose value is the coefficient for the EMA smoothing factor.
- Nick Rypock Moving Average (NRMA): This indicator is not part of the standard distribution of MetaTrader 5. This EMA is so trend-following that there are almost no fluctuations.
Here is the visual of the abovementioned Moving Averages:
DEMA and TEMA track price movements more accurately compared to regular EMAs. However, their constant fluctuations can give incorrect trading signals. Other indicators (FRAMA, AMA, VIDYA, NRMA) almost fluctuate and do not react to small price changes. In a trend, almost all indicators work in the same way.
See Also:Best Trading Strategy with Double EMA (DEMA)
Moving Average Keynotes
- All types of Moving Averages work well only when certain factors affect the market. This is great for a steady downtrend or uptrend. Whereas in the case of sideways movements, MA tends to be useless; traders should refrain from any trading activity during this period.
- When there is a spike, SMA cannot be used ideally because this tool assumes all prices are average values. In other words, it cannot react momentarily to sudden changes in market prices. If you find the incident, you may choose other types of Moving Averages such as EMA, LWMA, and SWMA.
- Keep in mind that the calculation of all types of MA only shows the market trend that has developed, not indicate the future trend.
Conclusion
Moving Averages are mainly used to identify forex market trends rather than giving trading signals as they are lagging indicators. They should be used with other technical tools such as price action to estimate the right time to buy or sell. By optimizing the parameters of the observed Moving Averages, a profitable strategy can be adopted.
Did you know that EMA is applicable to trade with a unique price chart like Heikin Ashi? Let's explore the strategy in The Complete Guide to Heikin Ashi EMA Strategy.
