By now,
you're probably asking yourself, which is better? The simple or the exponential
moving average?
First,
let's start with the exponential moving average. When you want a moving average
that will respond to the price action rather quickly, then a short period EMA
is the best way to go.
These can
help you catch trends very early (more on this later), which will result in
higher profit. In fact, the earlier you catch a trend, the longer you can ride
it and rake in those profits (boo yeah!).
The
downside to using the exponential moving average is that you might get faked
out during consolidation periods (oh no!).
Because
the moving average responds so quickly to the price, you might think a trend is
forming when it could just be a price spike. This would be a case of the
indicator being too fast for your own good.
With a
simple moving average, the opposite is true. When you want a moving average
that is smoother and slower to respond to price action, then a longer period
SMA is the best way to go.
This
would work well when looking at longer time frames, as it could give you an idea
of the overall trend.
Although
it is slow to respond to the price action, it could possibly save you from many
fake outs. The downside is that it might delay you too long, and you might miss
out on a good entry price or the trade altogether.
An easy
analogy to remember the difference between the two is to think of a hare and a
toirtoise.
The
tortoise is slow, like the SMA, so you might miss out on getting in on the
trend early. However, it has a hard shell to protect itself, and similarly,
using SMAs would help you avoid getting caught up in fakeouts.
On the
other hand, the hare is quick, like the EMA. It helps you catch the beginning
of the trend but you run the risk of getting sidetracked by fakeouts (or naps
if you're a sleepy trader).
Below is a table to help you remember the pros
and cons of each.
|
|
SMA
|
EMA
|
|
Pros
|
Displays
a smooth chart which eliminates most fakeouts.
|
Quick
Moving and is good at showing recent price swings.
|
|
Cons
|
Slow
moving, which may cause a a lag in buying and selling signals
|
More
prone to cause fakeouts and give errant signals.
|
So which
one is better?
It's
really up to you to decide.
Many
traders plot several different moving averages to give them both sides of the
story. They might use a longer period simple moving average to find out what
the overall trend is, and then use a shorter period exponential moving average
to find a good time to enter a trade.
There are
a number of trading strategies that are built around the use of moving
averages. In the following lessons, we will teach you:
1. How to
use moving averages to determine the trend
2. How to
incorporate the crossover of moving averages into your trading system
3. How
moving averages can be used as dynamic support and resistance
Time for
recess! Go find a chart and start playing with some moving averages! Try out
different types and try experimenting with different periods. In time, you will
find out which moving averages work best for you.
