A variation on the simple moving average is the exponential moving average, lets look at that now.
Exponential moving averages
Unlike the SMA, the EMA assigns more weight to the most recent price data. It is a rolling formula calculated as follows:
EMA = ((price – previous EMA) x Sm) + previous EMA
Sm – (2 / (n+1))
Sm is the smoothing constant and its what gives more prominence to the impact of the most recent price. We’ve provided a worked example in the spreadsheet on the materials tab.
Lag factor
All moving averages lag behind the price, how much it does so is called the lag factor. Because the EMA places more significance on the most recent price change it has less lag than an SMA for the same time period. The more time periods in the moving average the greater the lag factor.
Traders need to balance the need to confirm the trend against having to wait too long to confirm it and miss the move. Unfortunately, there is no best period to set a moving average to.
- The EMA weights the most recent prices more heavily than the SMA.
- Lag factor how much behind the price change the moving average is.
- There is always a trade-off between trend confirmation and lag.