Combining smas and emas
To identify the overall trend, moving averages can be very helpful. The moving averages show the average price of a currency at a specific point over a specific period of time. Moving averages are not perfect. To counteract this issue, it is best to use a short period of time when using moving averages.
This makes it more reflective of the recent price action than it would be if you use a longer period. However, the moving averages of short periods are subject to more false trend-change alerts. As an alternate, the trader can use the moving averages by combining two averages of different periods.
When the shorter-term average crosses over the longer-term average, buy signals are usually detected. Likewise, sell signals are detected when the shorter-term average falls below the longer-term average. Mathematically distinct moving averages have three main types: SMAs give equal importance to all of the data in the period.
Indicators and oscillators vary greatly in both their derivation and their usage. The indicators, which can be found right on the candles or price bars, include moving averages, Parabolic SAR, Bollinger Bands and much more.
These indicators are usually lagging, providing a historical view of the price action. The indicators can often confirm or provide clues as to the direction of present momentum and past trends. On the other hand, the oscillators are generally shown separately above or below the price bars. Like the indicators, the oscillators are also lagging. The oscillators are good at revealing oversold and overbought conditions.
Because of this, the oscillators are most useful for traders who would like to identify ranging circumstances, rather than trending circumstances. Other technical drawing tools are, like analysis tools, popular and also varied.
Many of these analyses are used to reveal areas of importance, such as the support and resistance levels. The most basic drawing tools are the trend lines, regardless of whether they are diagonal or horizontal.
Traders often use crossovers , where the graph of the shorter moving average crosses over a longer moving average, as a good indication of a new trend. Traders will often use the crossovers as a buy or sell signal and as a good price to set trailing stops. So if the shorter moving average crosses above the longer-term average, then this indicates a beginning of an uptrend, while a downward cross may indicate the beginning of a downtrend.
However, even crossovers may give false signals, particularly in whipsaw markets, so moving averages are often used with other technical indicators as a confirmation of the trend change. The problem with simple moving averages is that the earliest day of the time period has the same weight in the average as the most recent day.
If the earliest day was volatile, but the market has recently calmed, then the volatile day will have a large influence on the average—known as a drop-off effect —which would not best represent the current market.
To correct this anomaly, exponential moving averages EMA are used, where greater weight is given to more recent prices. This greater weight causes the EMA to follow the underlying prices more closely most of the time than the SMA of the same duration.
Although moving averages can be calculated in many different ways, the traditional method of calculating the EMA is to add an additional day to the simple moving average, but to give greater weight to the last day.
The formula to calculate the weight of the last day is:. So if XYZ stock had a day moving average of 25 yesterday , and the stock closed at 26 today, then:. There are many variations of the exponential moving average.
Many of these variations base their calculations of the EMA on the volatility of the market. Moving averages can easily be calculated using a spreadsheet or the software of a trading platform. Most major websites that provide stock prices, such as Yahoo , Google , and Bloomberg , also provide free charting tools that include moving averages.
Most of these tools also allow multiple moving averages to be plotted in the same graph—even SMAs and EMAs can be combined in the same graph. As stated earlier, moving averages can be calculated in many ways, and, likewise, can be used in many different ways. There is no persuading evidence that any method is better than any other, especially since there are infinite possible combinations of moving averages and other technical indicators.
The best use of moving averages is in determining trends. The greater the slope of the moving average, the greater the strength of the trend. Generally, traders will choose a time period that is suitable to their investment time frame. So a long-term trader will use a day average or longer, while a swing trader will use much shorter time frames. Crossovers of 1 or more moving averages over a longer-term moving average usually signify a change in trend and are also used as trading signals or to set trailing stops.
Another use of moving averages is to detect and profit from extreme prices. Prices that suddenly stray far from the average tend to revert to the average in the short term, especially when there is no significant news causing the price deviation, so short-term traders can profit from these deviations.
A moving average provides no trading signal and a crossover of 2 or more moving averages may come too late to take full advantage of a change in trend. Some traders, hoping to act early to take advantage of anticipated signals, look at the converging lines to see if they are likely to cross over or if the lines are diverging, reducing the likelihood of a crossover. But this is trading by intuition. Convergence and divergence can be quantified to generate a signal.
Convergence is the coming together of 2 or more indicators. With moving averages, it could be the sign of an impending change in trend.