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Chapter 11, Part III. Exponential Moving Average.

Discussion in 'Complete Trading Education- Forex Military School' started by Administrator, Jun 21, 2011.

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  1. Administrator

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    Part III. Exponential Moving Average. [​IMG]
    Commander in Pips: To estimate the value of am Exponential Moving Average (EMA) you need to the same three things:

    1. Specify number of trading periods that must be included in calculation;

    2. Specify the price type of period – close, high, low or even (High+ Low+ Close)/3. As a rule Close price is used for calculation. Possibilities for using of other prices types will depend on software, because not all software allows you to calculate SMA, say, for (High+ Low+ Close)/3. So, here we will talk about SMA on Close price;

    3. Calculate average value of these numbers using exponential way of averaging.

    [​IMG]

    Pipruit: And how is that?
    Commander in Pips: A bit later I’ll give you formula and we will try to estimate the value of some EMA, but let’s point out the first major difference between SMA and EMA.

    Pipruit: I remember, in previous part you’ve said that in SMA calculation each number has the same weight, so equal impact on overall value of SMA. But EMA points different weights, depending on recentness of each number – more weight have most recent numbers and less weight have most early numbers.​

    Commander in Pips: That’s correct. Let’s return to our calculation of 7-period SMA in previous chapter:

    Period NClose price
    11.4185
    21.4207
    31.4137
    41.3988
    51.3882
    61.3978
    71.3973
    SMA = (1.4185+1.4207+1.4137+1.3988+1.3882+1.3978+1.3973)/7 = 1.4050

    Now let’s assume, that on 6th day was macro data release near the close of the day and it was terrible, so that market has closed not at 1.3978, but at 1.3350, what will the number of SMA then?

    Pipruit: Let’s see:

    SMA = (1.4185+1.4207+1.4137+1.3988+1.3882+1.3350+1.3973)/7 = 1.3960

    Hm, it could drastically change a trader’s attitude to overall market situation. Because, although recent price action looks bullish – just single day can turn the SMA to the downside! And we estimate the possible short term trend as bearish.​

    Commander in Pips: That’s right. Here you can see, how equal weight for each number impact on the overall value of SMA. And it could change direction only due some extraordinary price action in a single day. But there is another way of averaging that exists. Using it could smooth out this bug. This is the Exponential Moving Average. It has a formula that points higher weight to most recent numbers and smaller weight to most old days:


    EMA(t)=EMA(t-1)+SF*(P(t) -EMA(t-1)) ;

    P(t) – is a price in period (t), that you intend to use in calculation. Usually, this is the close price;

    EMA(t) – is a most recent value of EMA;

    EMA(t-1) – is a previous recent value of EMA;

    SF – is a smoothing factor. As a rule it equals 2/(n+1), where n – is a number of periods of EMA

    Pipruit: Commander, it’s way too complicated…​
     
    #1 Administrator, Jun 21, 2011
    Lasted edited by : Mar 8, 2016
    Hamza Samiullah and fran alvarez like this.
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