If someone asked me what tool it the most used on common charting platforms, I would guess its the moving average (MA). If the follow up question was “Which moving average?”, then I’d be stumped. There are almost as many moving averages as there are chart types. There’s the Simple MA, Exponential MA, Weighted MA, Adaptive MA, Displaced MA, Momentum Simple MA, Hull MA, Legacy MA…the list goes on and on. I think it’s safe to say, however that the 2 most common are the Simple Moving Average (SMA) and the Exponential Moving Average (EMA). While they all have their uses, these 2 are the most regularly available on most trading Platforms, including the Nadex charting platform. So what’s the difference?
All moving averages have a specific number of price-inputs defined by the number of periods the traders chooses. For example a 10 period SMA has 10 inputs. A 20 period EMA has 20 inputs. The difference lies in the weighting of the inputs. An SMA is exactly what the name implies. It’s simply an average of the number of inputs the trader chooses, so if it’s a 10 period SMA, its the average of the last 10 prices (usually the closing prices) and each input has the same weighting in the final SMA; 10%. By contrast, an EMA gives more weight to recent price inputs, with past price inputs counting for less and less of the final average as time goes on. For example, in a 10 period EMA the most recent input (price #10) counts for 18.2% of the average. Counting down from there, price 9 is 14.9%, price 8 is 12.2%. price 7 is 10% price 6 is 8.1%…all the way to price 1 which is only 3% of the final EMA. So again, the key difference is the SMA weights all price inputs equally and the EMA gives greater weight to recent price inputs.
So which is better? The nature of the EMA means that it turns faster than the SMA. While much depends on the period a trader chooses, an SMA will not turn as quickly as an EMA of the same time period with the same number of inputs. So choosing one over the other depends on what it will be used for. Using MA’s by themselves to enter trades, even as crossover systems, have poor track records. They can both be very useful when trading Nadex binaries and spreads, as a signal to exit a binary or spread prior to expiration, but choose the faster moving EMA if you struggle emotionally while you are in trades, and the slower SMA if you prefer to hold until expiration. As with all trading advice, control your risk, get educated and then do your own research before implementing anything new into your strategy.