Every trader initially questions whether the EMA (exponential moving average) or the SMA (simple/smoothed moving average) should be used. Despite the fact that the differences between the two are usually minimal, the moving average you choose might have a major impact on your transaction. Here’s what you’ll need to know:
The EMA’s and SMA’s Differences
There is practically only one difference between EMA and SMA: speed. The EMA moves faster than the SMA and changes direction much more quickly. The EMA gives current price activity greater weight, suggesting that when price changes direction, the EMA notices it first, whilst the SMA takes longer.
Pros and Cons of EMA vs. SMA
There is no superior or worse when it comes to EMA vs. SMA. The benefits and drawbacks of the EMA are explained below:
The EMA reacts faster when the market changes direction, but this also makes it more susceptible to delivering false signals too early. When price retraces lower after a rally, for example, the EMA begins to flip down almost instantly, signifying a direction shift far too soon. The SMA moves much slower and might keep you in trades for longer when there are short-term market movements and chaotic activity. This does, however, imply that the SMA initiates trades later than the EMA.
The best periods for Swing Trading
Swing traders take a different approach, favoring higher time frames (4H, Daily +) and holding positions for longer periods of time. Swing traders should first choose a SMA and then use longer period moving averages to reduce noise and early signals. Swing traders should be mindful of the following four moving averages:
20 / 21 period: I prefer the 21 moving average for short-term swing trading. During trends, Price is particularly respectful of them, and it also indicates changes in trends.
50 period: The most commonly utilized swing-trading moving average is the 50 period moving average. It is widely used by traders to ride trends since it hits the ideal mix between being too short and too long.
100 period: Round numbers have a particular allure, and this is especially true when it comes to the 100 moving average. On a daily and/or weekly basis, it is especially beneficial for support and resistance.
200 / 250 period: The period of the 200 moving average and the period of the 250 moving average are the same. The 250 period moving average is popular on the daily chart since it represents one year of price action (one year has roughly 250 trading days)
How to use Moving Average
Let’s look at three ways moving averages may help you find trades, ride trends, and reliably exit positions now that you know the distinctions between moving averages and how to choose the right period setting.
1. Trend direction and filter
The Market Mastermind Marty Schwartz was one of the most successful traders of all time, and he was a firm believer in determining trend direction through moving averages. To stay on the right side of the market and filter out transactions that are headed in the wrong direction, Marty Schwartz uses a fast exponential moving average (EMA). This one tip can have a huge impact on your trading even if you just start trading with the trend in the right way.
The Golden Cross and the Cross of Death
Moving averages can be used as directional filters by swing traders, as well. The Golden and Death Cross are daily chart signals that occur when the 200 and 50-period moving averages cross. The Golden and Death cross entries in the chart below. Essentially, you would enter short when the 50 crosses the 200 period moving average and long when the 50 crosses above the 200 period moving average. Despite the fact that the screenshot only covers a short period of time, you can see how moving average cross-overs can aid your study and help you choose the best market direction.
2. Support and resistance placement, as well as a halt
Support and resistance trading, as well as stop placement, can all be aided by moving averages. Popular moving averages usually function as excellent support and resistance levels due to the self-fulfilling prophecy we outlined before.
A word of caution: Ranges vs. Trends
In range markets, moving averages are useless. When price fluctuates between support and resistance, the moving average is frequently in the middle of the range, and price pays little attention to it. A price chart with a 50- and 21-period moving average may be seen in the screenshot below. Moving averages absolutely lose their validity throughout the range, yet they correctly work as support and resistance once the market starts trending and swinging again.
3.Three Bollinger Bands Indicate the end of a Trend
Bollinger Bands are a technical indicator that is based on moving averages. The Bollinger Bands have a 20-period moving average in the middle, while the outer Bands assess price volatility. During ranges, the price fluctuates around the moving average, but the outer Bands are still quite important. When price approaches the outer Bands during a range, it often indicates a reversal in the other direction, particularly if it is followed by a rejection. The Bollinger Bands are a great tool for properly assessing price, even if moving averages lose their validity throughout ranges.
Bollinger Bands can help you to stay in transactions during trends. During a strong trend, the price tends to move away from the moving average, but near to the Outer Band. When price breaks the moving average again, it may indicate a shift in trend. Furthermore, anytime the outer Band is violated during a trend, it often signals a pullback – but this does not indicate a reversal until the moving average is broken.
As you can see, moving averages are a versatile tool that may be used in a variety of ways. After a trader understands the differences between EMA and SMA, the relevance of the self-fulfilling prophecy, and how to choose the right period setting, moving averages become an important tool in their toolkit.
Swing traders, on the other hand, favor higher time frames (4H, Daily +) and hold positions for longer periods of time. Initially, every trader wonders whether to employ the EMA (exponential moving average) or the SMA (simple/smoothed moving average). Although the variations between the two are usually minor, the moving average you choose could have a significant impact on your transaction.