Simple vs Exponential Moving Averages

A few readers have asked about the difference between Simple and Exponential Moving Averages and I wanted to address that in an educational post.

In my charting, I utilize the 20 and 50 period Exponential Moving Average (EMA) and also the 200 period Simple Moving Average (SMA).  I do this because I want the shorter averages to track the prices closer – and I’m interested in the spread along with the ‘orientation’ of the 20 and 50 EMAs, but I also want to see an average price over the last 200 trading days that is unweighted, thus I use the SMA for longer-term purposes.  Also, many funds follow the 200 day or week SMA and that might be all the technical analysis they use, so it tends to cause ‘reactions’ and is an important level to watch.

I like to use the 20 and 50 EMAs to help determine structure (uptrend/downtrend) and also to develop low-risk, high probability trade set-ups (entries) in a trending environment (buying pullbacks to the 20 or 50 EMA in a rising trend, for example).

So what is the difference between Simple and Exponential Averages?

Rather than recreate the wheel for you, I want to direct you to the most comprehensive free resource on moving averages I’ve seen on the web, which is StockCharts.com’s article on Moving Averages.  Here are a few key points pulled from that article:

“A simple moving average is formed by computing the average (mean) price of a security over a specified number of periods.

Exponential Moving Averages reduce the lag by applying more weight to recent prices relative to older prices.  In order to reduce the lag in simple moving averages, technicians often use EMAs.

The initial thought for some is that greater sensitivity and quicker signals are bound to be beneficial. This is not always true and brings up a great dilemma for the technical analyst: the trade off between sensitivity and reliability.

All moving averages are lagging indicators and will always be “behind” the price.  When prices are trending, moving averages work well. However, when prices are not trending, moving averages can give misleading signals.”

In sum:  “The exponential moving average is consistently closer to the actual price.”

Which is Better?

Good question!  I wanted to quote from the StreetAuthority.com’s MA Article for a succinct answer:

“What is the purpose of the exponential moving average? Moving averages are lagging indicators, and therefore, by definition, will give late signals. By weighting recent price data more heavily, exponential moving averages attempt to speed up the signal given. The disadvantage of doing this, of course, is that this more-rapid signal can sometimes be premature and therefore give the swing trader a false indication to trade.”

Ultimately, it comes down to your experience and even the character of a given security – some tend to ‘work’ better with SMAs while others do so with EMAs – it takes practice and experience to find the balance that works for you.  There are no quick answers unfortunately.

Through my experience and trading style, I’ve compromised and settled on the 20 and 50 EMAs along with the 200 SMAs, though I know many traders who do quite well with many other combinations.

Browse these two articles for full details and feel free to share your experiences in the comment section so we can learn from each other.

Corey Rosenbloom
Afraid to Trade.com