Forex technical analysis indicators: exponential moving average.
As we mentioned in the previous lesson, the simple moving average trend can be distorted by huge price fluctuations in the short term.


Let’s take a look at the EUR/USD 5-day moving average.

The closing prices of the exchange rates in the past 5 days are:
 
Day 1: 1.3172
Day 2: 1.3231
Day 3: 1.3164
Fourth day: 1.3186
Day 5: 1.3293
 
The calculation result of the simple moving average is as follows:
 
(1.3172 + 1.3231 + 1.3164 + 1.3186 + 1.3293) / 5 = 1.3209
 
It’s simple, isn’t it?
 
So, if there is an emergency on the next day that causes the EUR/USD to close down and close at 1.3000. Let us look at the impact of this change on the simple moving average of EUR/USD on the 5th.
 
Day 1: 1.3172
Day 2: 1.3000
Day 3: 1.3164
Fourth day: 1.3186
Day 5: 1.3293
 
The simple moving average calculation result will become:
 
(1.3172 + 1.3000 + 1.3164 + 1.3186 + 1.3293) / 5 = 1.3163
 
The calculation result of this simple moving average will be much lower than before, and may give you the impression that the price is actually going down. In fact, the price movement of the next day is only a single order that is affected by bad economic data Day event.
 
We need to point out that the simple moving average may sometimes be too simple. If you can filter out these short-term excessive volatility factors, then you will not draw wrong judgments.
 
Exponential moving average is one way!
 
The exponential moving average (EMA) gives more weight to the most recent period. In the example we gave earlier, the exponential moving average will give the price a higher weight in the last few days, which will be the third, fourth and fifth days.
 
This means that the huge price fluctuations on the second day will not have a big impact on the movement of the moving average, as we calculated through the simple moving average.
 
If you notice this, it will be very meaningful, because the exponential moving average emphasizes the recent behavior of traders.
 
Let’s look at the different movements of SMA and EMA in the same chart of the USD/JPY 4-hour chart.

Note: The red curve (30EMA) is closer to the price trend than the blue line (30SMA). This means that the red curve is more representative of recent price movements. You are probably able to guess how this happened.
 
Because EMA puts more emphasis on recent price movements, recent trader behavior is far more important than their trading behavior in the last week or last month.

SMA and EMA

As of now, you may be asking yourself, SMA or EMA, which one is better?
 
Let’s start with the exponential moving average. When you need a moving average that responds very quickly to price movements, then a short-term EMA will be the best option.
 
EMA can help you to grasp the direction of trend fluctuations in the early stage, and you will also make a lot of profits. In fact, the earlier you catch the trend, the more profit you will make.
 
Because the EMA’s response to prices is so rapid, when prices are only briefly transiently volatile, you might think that a trend is taking shape.
 
The SMA situation is the exact opposite of the EMA situation. When you need a moving average that is smoother and more responsive to prices, a long-term SMA will be your best choice.
 
The long-term SMA has a significant effect on the long-term chart, because it can provide traders with an overall trend direction.
 
Although it responds slowly to prices, it is very likely to avoid the losses you suffered from false quotes. However, the disadvantage of SMA is that it may delay you the best time to enter.
With the help of SMA analysis, you may miss the best time to enter the market early in the trend. However, it has a “hard shell” to protect itself, that is to say, SMA is more able to help you avoid being deceived by false market.
 
The rabbit on the right runs fast, like an EMA. It can help you seize the best time to enter the market at the beginning of the trend, but there is a risk of being deceived by false market.
 
So, which tool is better?
 
This is actually up to you.
 
Some traders will combine EMA and SMA. They may use the long-term SMA to find the direction of the trend, and then use the short-term EMA to find the best entry point.