Simple, Weighted, and Exponential Moving Averages: The Differences
Moving averages (MAs) are commonly used indicators in technical analysis; in fact, they are among the first indicators traders will consult when forming a trading strategy.
There are several types of averages, including a simple moving average (SMA), a weighted moving average (WMA), and an exponential moving average (EMA), each with its unique features. In this FXOpen article, we compare SMA vs EMA vs WMA and explore how to use MA indicators in trading.
What Is an MA in Trading?
A moving average (MA) in trading is a tool used to analyse market movements over a specific period. Represented as a line on a chart, an MA indicator smooths out fluctuations by averaging the data points over the selected timeframe. This helps traders identify trends and make decisions about when to buy or sell.
The moving average meaning varies based on the type and calculation method, but the core function is to filter out short-term noise and highlight the underlying trend. The primary difference between various MAs lies in the weight given to recent versus older data points. Some give equal weight to all data, while others emphasise recent movements, making them more sensitive to current market conditions.
While MAs were calculated manually in the past, trading platforms like TickTrader enable traders to simply click and add these indicators to their charts. The only setting to change is the number of periods being analysed, also known as the length.
What Is a Simple Moving Average?
The simple moving average was the first type of MA traders used in technical analysis, and this is because it is straightforward to calculate. The average is the sum of the data points for the specified period divided by the number of periods. It applies equal weighting to each data point.
The calculation typically uses closing prices, but it can also include other data, such as opening prices or median prices. The average moves over time as the oldest value from the series is removed when a new period is added.
Traders often look at 9, 21, 50, 100, and 200 periods. For example, a 20-day MA is the average closing price for an asset over the last 20 days. On the next day, the most recent closing price is added, and the oldest value is dropped from the calculation.
MAs are smoother when measuring longer periods. This allows traders to filter market noise. However, such MAs have a greater lag with the current price.
What Is a Weighted Moving Average?
What is a weighted moving average definition? A weighted MA is a type of moving average that gives more weight to the most recent data in the series. The newest data has a stronger impact on the direction of the line, so the WMA follows prices more closely than an MA.
The moving average calculation multiplies each input by a weighting factor. The weighting factor is defined by the period being analysed, represented by n in the formula. As WMAs give a higher weight to the most recent data points, they are more relevant to the current price action. However, the formula can also be customised to give more weight to historical data if the trader is examining long-term price trends or wants to de-emphasise recent volatility.
Here is how you could calculate a weighted moving average. Lets take a weighted moving average example over three days. If a stock closed at $61, $58 and $63, the calculation would be based on a weighting of 3 for the $63 close on the most recent day, 2 for the $58 close on the second most recent day and 1 for the furthest close at $61. The 3-period weighted moving average calculation based on the formula would be: [(3 x 63) + (2 x 58) + (1 x 61)] / 3 * (3+1)/2 = 366/6 = 61
How is the WMA different from the MA? As it places more emphasis on more recent data, the weighted MA tends to be more sensitive to price changes. It has a shorter delay and offers the ability to identify trends faster.
What Is an Exponential Moving Average?
What is the EMA? Like the weighted moving average, the exponential moving average formula places more emphasis on recent data. The difference between an exponential moving average and a weighted moving average is that while the WMA reduces the weighting of prices further in the past in a linear fashion, the EMA reduces it exponentially. In what way does this affect how to calculate an exponential moving average?
To calculate the weighting multiplier (K), divide 2 by the sum of the number of periods plus 1.
Next, compute the EMA for a particular period by subtracting the previous period's EMA from the current closing price, multiplying the result by K, and then adding the previous EMA.
As with WMAs, traders analyse EMA indicators to identify price trends. When a trend changes direction, the EMA reacts faster as it gives more importance to recent data points and exponentially less to the data from the beginning of the period. This difference can be noticed by visually comparing an EMA vs an SMA on a chart.
How Can You Trade with MAs?
As MAs are based on past data, they are lagging indicators that are not very useful to reflect upcoming trends. However, they demonstrate the direction in which an asset has moved, so they can confirm existing trends. The MA lines on a price chart smooth out data that may be visually noisy to help make trading decisions.
Traders analyse MA, WMA, and EMA chart indicators to identify trend direction and support and resistance levels and confirm trends with crossovers.
Trend Direction
An MA indicator can confirm the trend direction. If the MA line points higher, the asset is in an upward trend, whereas a falling MA would indicate a downward trend. Traders tend to look at 21-period MAs to gauge short-term trends, 50-period MAs to analyse intermediate-term trends, and 200-period MAs to determine long-term trends.
If an asset is trading above a rising MA, it indicates an upward trend (1). If the price is moving below the MA, the trend is bearish (2). A price crossing over the moving average in either direction can provide the first sign that a trend is reversing course. When a price crosses above the MA, a trader might open a long position or close a short position, and when a price crosses below the MA, they might go short or close a long position.
Support and Resistance
Traders use MAs to identify support and resistance levels. A rising MA tends to indicate a dynamic support level, acting as a floor that the price bounces up from and giving a buy signal (1). A falling MA is used as resistance, allowing traders to open a sell trade at a rebound (2).
Keep in mind that prices can break through support and resistance levels. The previous support level becomes resistance on a break below the MA (3), and the previous resistance becomes support on a break above.
Crossovers
Moving averages also create buy and sell signals when they cross each other. The golden cross is a bullish signal that occurs when a short-term moving average (e.g. 21-day MA) crosses above a long-term moving average (e.g. 50-day MA), which a trader would take as a signal to take a long position (1). Conversely, the death cross is a bearish signal that occurs when a short-term MA crosses below a long-term MA, and it prompts a trader to go short (2).
Which Moving Average Is More Effective?
Moving average vs weighted moving average vs exponential smoothing: which is the most effective trading tool?
The effectiveness of one type of MA over another will depend on the trading strategy used. One MA is not inherently better than the others; they simply calculate the average price for a period in different ways.
Some traders view an EMA (black) as a clearer indicator of a trend and more responsive than a WMA (grey) or MA (orange) because of the greater weight given to more recent prices, which helps them identify precise support and resistance areas and get an early signal of a trend change. However, some view an SMA as more effective on higher timeframes as it provides basic smoothing and doesnt react to recent price movements.
Short-term traders might not have a strong preference for using the EMA vs WMA as the values are likely to be closer together. As an EMA and a WMA give less emphasis to older data points, traders choose them over an SMA if they are concerned that a lag in the data could reduce the responsiveness to sharp price changes.
If you want to incorporate MAs into your technical analysis, experiment with different combinations to determine which one generates the best results for your trading approach. You might opt to use different MAs for different assets; for instance, analysing assets like blue-chip stocks with a simple moving average vs an exponential moving average for volatile cryptocurrencies*.
Takeaway
Simple, weighted, and exponential moving averages offer unique advantages depending on the trading strategy and market conditions. The simple moving average provides a straightforward average of prices over a specified period, making it easy to calculate but slower to react to price changes. The weighted moving average gives more importance to recent prices, offering a faster response to market movements while still smoothing out data. The exponential moving average emphasises recent prices even more, making it the most responsive of the three, which can be particularly useful in volatile markets.
Understanding the differences among these moving averages allows traders to choose the one that best aligns with their trading goals and market analysis. If you want to learn more about how to use MAs, open an FXOpen account to practise using the indicators on live price charts and enjoy fast trade execution, low commissions, and tight spreads. Good luck!
FAQ
What Is SMA and WMA?
The simple moving average (SMA) calculates the mean price of an asset over a specific period by applying equal weight to all data points. The weighted moving average (WMA), however, assigns greater weight to the most recent movements, making it more responsive to current price changes.
Is EMA Better Than WMA?
The EMA is often considered more responsive than the WMA because it places exponentially greater weight on recent data. Whether a weighted moving average vs an exponential moving average is better depends on the strategy and the desired sensitivity to market movements.
How Does a Weighted Moving Average Differ From a Simple Moving Average?
The simple moving average vs weighted moving average difference comes down to the WMA giving greater weight to recent periods, which makes it more responsive to new data. The SMA applies equal weight to all data points within the selected period.
What Is the Difference Between a Simple Average and a Weighted Average?
The weighted MA vs SMA difference is effectively how weights are assigned. A SMA evenly weighs all data points, while a WMA assigns different weights, often emphasising more recent or relevant data.
Should I Use EMA or SMA for Swing Trading?
Given the difference between EMA and SMA, in that the EMA is more sensitive to recent asset changes, swing traders often prefer the EMA for its ability to provide quicker signals.
What EMA Is Best for Scalping?
For scalping, shorter-period EMAs, like 5 or 10, are often preferred to capture quick movements.
What Is WMA Trading?
WMA trading involves using the indicator to identify trends and potential entry and exit points based on the most recent market data.
*At FXOpen UK and FXOpen AU, Cryptocurrency CFDs are only available for trading by those clients categorised as Professional clients under FCA Rules and Professional clients under ASIC Rules, respectively. They are not available for trading by Retail clients.
Text source: Forex Trading Blog
