The exponential moving average, like the simple moving average, offers a smoothed correlation between price action and the passage of time. The difference is that the calculation of the exponential moving average gives more importance to the latest data obtained during a certain period.
EMA (t) = EMA (t – 1) + K * [Price (t) – EMA (t – 1)]
t = current value
t-1 = previous value
K = 2 / (n + 1) (n = period chosen for EMA)
The EMA for the first session of the calculation period coincides with the value of the simple moving average.
As you can see, to calculate the current value of the EMA, the value of the immediately previous EMA and the current price are taken into account, therefore, the last values have more weight in the final result than the first values of the calculation period.
In practice this translates into a faster reaction to recent changes in the price action of a currency pair. In this way, possible high-range spikes in price (known as spikes) are also mitigated in recent EMA values.
For example, if we have the values 5,2,4,6,7, we see how in general the series has an increasing trend. You can see how a low spike occurred in the second value. The simple moving average gives the same weight to this peak as to the rest of the values, being able to reflect a confusing current value while the exponential moving average would give a more current, higher value, mitigating the downward peak of the second value and reacting more quickly to recent uploads.
Now you ask yourself, if the EMA is so good, why do we want the SMA?
Both have their utility and the advantages of one become the disadvantages of the other and vice versa. For example, the EMA can give more false signals than the SMA by moving faster with the current price action, the SMA would be better to avoid this, however this same characteristic causes the SMA to move more slowly and can give the signals too much late and make you enter the market when a movement is almost finished, in this case an EMA would be better to enter the market as quickly as possible when a new trend is detected.
Deciding which one to use will be up to you, if you decide to use moving averages in your analysis. If you want to have quick information, a short period EMA would be the best, on the contrary, if you are looking for information on a lasting dominant trend, the best would be a long period SMA.
The common thing is to use a set of moving averages with different calculation periods. For example, a long-term moving average that provides us with the dominant general trend in the market and a short-term moving average that provides us with information about the price action in a more current way and gives us a good entry point in the direction of the main trend. This entry point would be a crossover of two or more moving averages, you will get tired of hearing “moving average crossovers” as part of trading systems.
Quickly: The moving average crossover consists of going long when the shorter period moving average crosses a longer period moving average bottom up. The signal to enter a sell will be when the shorter period moving average crosses up and down a longer period moving average.