Moving averages: SMA, EMA and crossovers

The moving average is probably the most widely used indicator in the world. It is simple, available on every platform, and lots of participants watch it at the same time, which gives it a kind of collective effectiveness. Used well, it helps you read the trend at a glance. Misunderstood, it produces late signals and repeated losses.

The principle: smoothing out the noise

A moving average calculates the average of the last N closes and starts again with every new candle. The oldest close drops out, the newest one comes in: the average "slides" over time. Joined together, these points form a curve that follows price while ironing out its small swings.

SMA or EMA

The SMA (Simple Moving Average) gives every close the same weight. The EMA (Exponential Moving Average) gives more weight to recent closes. For a 20-period EMA, the latest close accounts for about 9.5% of the new value, the rest coming from the previous EMA. The result: the EMA reacts faster to reversals, but it is also more easily fooled by a false move.

The 20, 50 and 200 periods

You can choose any period, but three show up everywhere because they have become conventions. The more widely they are followed, the cleaner the reactions around them.

• 20 periods: the short-term trend, roughly one trading month on D1. Useful for tracking the pace of a move.
• 50 periods: the intermediate trend. It often acts as a pullback zone in a healthy trend.
• 200 periods: the underlying trend. On D1, many investors consider a market above its 200 SMA to be in a long-term uptrend, and the opposite below it.

Crossovers

The best-known signal is the crossover of two averages. When a fast average moves above a slow one, it is a bullish signal; when it moves below, a bearish one. The crossover of the 50 SMA and the 200 SMA on D1 even has nicknames: the golden cross on the way up, the death cross on the way down.

Look closely at where the crossover sits on the chart: it comes after the low, once a good part of the rally has already happened. That is unavoidable, since each average is calculated from past prices. A crossover confirms a trend, it does not anticipate it.

The average as dynamic support

In a well-established trend, price often comes back to touch an average before moving on. In an uptrend, the 20 EMA or the 50 SMA then behaves like support that rises with price. Many traders wait for a pullback to that average, combined with a candlestick pattern, to enter in the direction of the trend.

Don't treat the average as an exact line. Price often overshoots it by a few pips, or even cuts through it briefly. As with classic support, think in terms of a zone around the curve.

Lag, the main limitation

Every moving average lags price. The longer the period, the bigger the lag. In a range, that lag becomes a real problem: price oscillates around the averages, crossovers follow one another in both directions and each one triggers a small loss. That is why you start by identifying market structure before following a crossover.

To limit this problem, many traders add a filter. For example, they only take a bullish 20 EMA / 50 EMA crossover if price is above the 200 SMA and the 200 SMA itself is rising. The filter costs a few valid signals, but it removes many bad ones. Another solution is to wait for a full candle to close after the crossover, rather than acting as soon as the lines touch mid-session.

• Common mistake: changing your average's period every time it doesn't fit the latest move.
• Common mistake: stacking six averages on the same chart until you can no longer see price.
• Good practice: choose two or three standard periods and keep them across all your markets.

To start, add a 20 EMA and a 200 SMA to a D1 chart. The 200 SMA tells you which side to favour, the 20 EMA shows you the pace and the pullback zones. These two lines are more than enough to begin with, no need to stack five more.