Moving averages are favored tools of active traders to measure momentum. The primary difference between a simple moving average, weighted moving average, and the exponential moving average is the formula used to create the average.
Moving averages are technical indicators used by traders to see the average price movement over a certain period.
The main difference between simple moving average, weighted moving average, and exponential moving average is the sensitivity that each shows to changes in the data used.
SMA calculates the average price over a specific period, while WMA gives more weight to current data.
EMA is also weighted toward the most recent prices, but the rate of decrease between one price and its preceding price is not consistent but exponential.
Simple Moving Average
The simple moving average (SMA) was prevalent before the emergence of computers because it is easy to calculate. Today's processing power has made other types of moving averages and technical indicators easier to measure. A moving average is calculated from the average closing prices for a specified period. A moving average typically uses daily closing prices, but it can also be calculated for other timeframes.
Other price data such as the opening price or the median price can also be used. At the end of the new price period, that data is added to the calculation while the oldest price data in the series is eliminated.
Weighted Moving Average
Weighted moving averages assign a heavier weighting to more current data points since they are more relevant than data points in the distant past. The sum of the weighting should add up to 1 (or 100%). In the case of the simple moving average, the weightings are equally distributed, which is why they are not shown in the table above.
Exponential Moving Averages
Exponential moving averages (EMAs) are also weighted toward the most recent prices, but the rate of decrease between one price and its preceding price is not consistent. The difference in the decrease is exponential. Rather than every preceding weight being 1.0 smaller than the weight in front of it, there might be a difference between the first two period weights of 1.0, a difference of 1.2 for the two periods after those periods, and so on.
Which Moving Average Is More Effective?
Because an exponential moving average (EMA) uses an exponentially weighted multiplier to give more weight to recent prices, some believe it is a better indicator of a trend compared to a WMA or SMA. Some believe that the EMA is more responsive to changes in trends. On the other hand, the more basic smoothing provided by the SMA may render it more effective for finding simple support and resistance areas on a chart. In general, moving averages smooth price data that can otherwise be visually noisy.
The functions of an EMA and a WMA are similar, they rely more heavily on the most recent prices and place less value on older prices. Traders use these EMAs and WMAs over SMAs if they are concerned that the effects of lags in data may reduce the responsiveness of the moving average indicator.
All moving averages have a significant drawback in that they are lagging indicators. Since moving averages are based on prior data, they suffer a time lag before they reflect a change in trend. A token price may move sharply before a moving average can show a trend change. A shorter moving average suffers from less lag than a longer moving average.
Still, this lag is useful for certain technical indicators known as moving average crossovers. The technical indicator known as the death cross occurs when the 50-day SMA crosses below the 200-day SMA, and it is considered a bearish signal. An opposite indicator, known as the golden cross, is created when the 50-day SMA crosses above the 200-day SMA, and it is considered a bullish signal.
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