Moving Average (SMA, EMA, SMMA, LWMA)

The idea in plain words

Instead of looking at every jump, you look at the average price of the last few candles, and you keep updating it as new candles arrive. If the average is rising, prices have generally been going up. Different types differ only in how much weight they give to the newest prices.

How it is calculated

Simple (SMA) gives every candle the same weight. Exponential (EMA) and smoothed (SMMA) give recent candles more weight, so they react faster (EMA) or more gently (SMMA). Linear weighted (LWMA) gives the newest candle the most weight and each older one a little less.

SMA = (sum of the last N closes) ÷ N
EMA today = EMA yesterday + k × (close − EMA yesterday),  k = 2 ÷ (N + 1)
SMMA today = SMMA yesterday + (close − SMMA yesterday) ÷ N
LWMA = (N×newest + (N−1)×next … + 1×oldest) ÷ (N + (N−1) + … + 1)

How to use it

• Trend direction: price above a rising average means an uptrend; below a falling one, a downtrend.
• Two averages (for example 20 and 50): when the faster one crosses above the slower one, momentum has turned up.
• Dynamic support: in strong trends the price often pulls back to a moving average and bounces.

Drawing conclusions

• A flat average with price crossing back and forth means there is no clear trend: crossovers are unreliable then.
• The longer the period, the slower and more reliable, but the later the signal.
• Popular periods: 20 (about a month of daily candles), 50 and 200 (long-term trend).

Watch out for

• Averages lag: they confirm a trend after it has started, they do not predict it.
• In sideways markets crossovers give many false signals.

A little history

Moving averages are among the oldest tools of chart analysis and were used by traders well before computers. The "golden cross" (50-day average crossing above the 200-day) became a popular long-term signal in the second half of the 20th century.