June 30, 2010
200 Day Moving Averages - SMA v EMA v TEMA
The 200 day moving average is one of the most widely used technical indicators because when applied to the long-term charts it gives you a great indication of the long-term trend. If the moving average indicator is sloping upwards then the price is in an upward trend, and if it's sloping downwards the price is obviously in a downward trend.
However it's worth noting that there are different types of moving averages that you can use. Most traders tend to use either the simple moving average (SMA) or the exponential moving average (EMA), but I also like to use the triple exponential moving average (TEMA) as well.
So how do they compare, and which one is the most effective?
Well they all have their merits but before I discuss this in more detail, let me first of all show you a daily chart of the EUR/USD pair with these three indicators included on the chart.
SMA (200) = blue
EMA (200) = pink
TEMA (200) = black
As you can see the indicator that tracks the price the closest and alerts you to a change in trend the earliest is the TEMA. This indicator started falling back in December last year when the price was around 1.4500 (and has continued to fall since then as well with the price currently standing at 1.2227).
The EMA was the next to alert us to a change in trend. After a period of consolidation when this indicator flattened out for a month or so, the price fell below this indicator and the indicator started to fall over a month later at the end of January with the price now around the 1.4000 level, ie 500 pips later.
The SMA was clearly the last indicator to turn downwards. Indeed it was still sloping upwards whilst the price was falling from 1.5150 to 1.4000. It only started turning downwards in March this year, by which time the price was already down to 1.3500, which is around 500 pips later than the EMA and 1000 pips later than the TEMA.
So the point I want to make is that although they all give an indication of the current long-term trend, they do not all give the same results. The TEMA will always get you into a trend the earliest, followed by the EMA and then lastly the SMA.
However whilst the TEMA is arguably the most effective 200 day moving average, you shouldn't necessarily abandon the other two moving averages completely simply because the vast majority of traders around the world still use these two indicators to highlight the trend and help them enter and exit positions, so they carry a lot of weight. Furthermore many traders also trade moving average crossovers using the simple or exponential moving averages (often entering positions when the 50 crosses the 200).
So as I said earlier, each of these three indicators has their merits and there's no reason why you shouldn't apply all three of them to your long-term charts to give you a complete picture of the long-term trend.