Let’s say we plot a 5-period SMA on the daily chart of EUR/USD.

The closing prices for the last 5 days are as follows:

On Day 1: 1.3172

Day 2: 1.3231

On Day 3: 1.3164

Day 4: 1.3186

On Day 5: 1.3293

Calculating a Simple Moving Average

We would calculate the simple moving average as follows:

(1.3172 + 1.3231 + 1.3164 + 1.3186 + 1.3293) / 5 = 1.3209

Simple enough, right?

Well, what if there was a news report on Day 2 that causes the euro to drop across the board?

This causes EUR/USD to plunge and close at 1.3000. Let’s see what effect this would have on the 5-period SMA.

Day 1: 1.3172

On Day 2: 1.3000

Day 3: 1.3164

On Day 4: 1.3186

Day 5: 1.3293

We would calculate the simple moving average as follows:

(1.3172 + 1.3000 + 1.3164 + 1.3186 + 1.3293) / 5 = 1.3163

Distorted Results

The result of the simple moving average would be a lot lower and it would give you the notion that the price was actually going down when in reality, Day 2 was just a one-time event caused by the poor results of an economic report.

The point we’re trying to make is that sometimes the simple moving average might be too simple.

If only there was a way that you could filter out these spikes so that you wouldn’t get the wrong idea.

Hmm… Wait a minute… Yep, there is a way!

It’s called the Exponential Moving Average!