Moving averages are the cornerstone of technical analysis, proving to be one of the most powerful and commonly applied trading indicators. Moving averages are indicators that help traders/investors smooth prices for a unit of service over time (a specified period). They used to identify, ultimately, the direction of the underlying trend of a stock, commodity, or currency pair.
But the minute you start looking into the topic, you immediately stumble across the fundamental question: which moving average do I use? The historical debate of SMA vs EMA. That is, the Simple Moving Average or Exponential Moving Average. This ultimate guide will help explain the differences and help you use the right tool for your trading strategy.
If you want to master all of these and some additional technical tools, check out the Technical Analysis Crash Course or the Advanced Technical Analysis Course, our more in-depth course that covers a comprehensive breakdown of useful technical tools.
What Is The Simple Moving Average (SMA)?
The Simple Moving Average (SMA) is the most basic form of a moving average. As the name implies, the SMA is simply the arithmetic mean of a specific number of time periods (e.g., 50 days, 200 bars, etc.) of a security's prices.
What makes the SMA formula attractive is its very straightforward concept; every price within the time period is weighted in the same way.
SMA = Sum of Closing Prices Over N Periods / N
For a 20-day SMA, you add up the closing prices of the last 20 trading days and divide the total by 20.
Characteristics and Use of SMA
The most important property of the SMA is the smoothness of the line. It equally weighs older data as it does the most recent data, so it is slower, or more lagging, than other indicators.
Pros: The SMA is good at filtering out "noise" or random price spikes over a shorter time frame so that traders have a clearer view of the long-term trend.
Cons: The lag can create a late signal, which can lead to a poorly timed entry or exit, especially in a fast-moving market.
Traders who primarily rely on an SMA are those who trade periodically and investors who trade on the long side. To understand more about the fundamental principles to better help you trade with these long-term trends, check out this blog on Fundamental Analysis in Stock Market.
What Is The Exponential Moving Average (EMA)?
The Exponential Moving Average (EMA) gives a more sophisticated type of moving average. It was designed to rectify the main negative effect of an SMA, which is slow movement.
EMA Calculation
The EMA formula weights the recent prices greater than the old prices in the data set. This leads to a weighting that declines exponentially as the data gets older; for this reason, it is considered to be a weighted moving average.
EMA = (Closing Price - Previous Day’s EMA) × Multiplier + Previous Day’s EMA
The crucial component is the multiplier (or smoothing factor). The multiplier provides a measure of how much importance is placed on the latest price when calculating the value of the EMA, and the importance placed on the latest price is always greater than the previous price.
Characteristics and Use of EMA
The primary benefit of EMA is that price momentum is always taken into account more than price history because it places greater weight on the most recent price action than the SMA.
Pros: There is less lag, and it reacts faster to changing trends or an abrupt change in market sentiment, which makes EMA a vital tool for momentum trading.
Cons: The increase in sensitivity may produce more signals (or whipsaws) during a consolidating market or the development of a more sideways market.
EMA is critical for short-term trading, including intraday trading and swing trading. To learn about a short-term trading strategy, read our comparison: Swing Trading vs Day Trading.
SMA vs EMA - All Differences
The major differences present themselves as an active trader using the Simple Moving Average or Exponential Moving Average.
For people interested in developing the skills to actively trade using these indicators, please see our Stock Market Professional Courses.
When to Use Each Moving Average?
Ultimately, it is not about which is "better," but it is about which is more suited to your trading style and market conditions.
Use the SMA When:
You are a long-term investor: Investors tend to track the 50-day SMA and 200-day SMA to assess the macro trend direction. If the price is above the 200-day SMA, the long-term trend is believed to be bullish.
You need stable support and resistance: The clean look of the SMA makes it more favorable for defining key prices where the price is likely to bounce or encounter resistance in the trend.
The market is choppy: The smoothing effect of the SMA will help you filter through all the noise and pay attention to the underlying trend.
Use the EMA When:
You are a short-term or intraday trader: A quick reaction time is crucial, especially when using strategies such as scalping or for intra-daily trading ideas to catch the fast momentum change. 9-period and 20-period EMAs are popular periods that traders monitor.
The price is trending strongly: When a stock is moving up or down quickly, the EMA will closely follow the price action, giving the trader better entry and profitable exit prices/options.
You are using Crossover Strategies: The EMA is a component of the most popular momentum indicator, Moving Average Convergence Divergence (MACD), and being fast is an essential part of using the short-term moving average crossover method. For mastery in this aspect of technical analysis, read How to Use MACD Indicator?.
Most likely, the best strategy is a blended approach: use a longer-term SMA to confirm the overall trend, and a shorter-term EMA to time entries.
If you want to become a ninja at technical setups, you should look into our Technical Analysis Course or our Stock Market Trading Beginners Course for Investors and Traders.
Conclusion
The Simple Moving Average and the Exponential Moving Average both have their merits as technical analysis tools, but one should serve the other well. SMA provides insight and stability for the bigger picture, and EMA provides speed and sensitivity for tactical, short-term moves.
As a trader, the goal is to create a robust system, not find the perfect indicator. When you know the difference in weight and lag between SMA vs EMA, you can decide the best method of action that can improve your market timing and profits.
To implement these methods, you can start your journey with our flagship Stock Market Training Online Courses.
FAQs
Q1. Which is better for intraday trading, SMA or EMA?
A: Typically, intraday traders prefer the EMA (Exponential Moving Average) as it has less lag and reacts quickly to price changes minute-by-minute. This added responsiveness allows for capturing the short-term momentum and a quicker trade signal.
Q2. What is a Moving Average Crossover?
A: When the moving average that uses a shorter period crosses over the moving average that uses a longer period, this is known as a Moving Average Crossover and is a trading signal. A Golden Cross (short MA above long MA) indicates bullish, while a Deiath Cross (short MA below long MA) indicates bearish. Traders will use both types of moving averages, the simple moving average (SMA), or EMA.
Q3. Is the Moving Average a lagging or leading indicator?
A: Also remember that the Moving Average (both SMA and EMA) is a lagging indicator, as it is calculated from the price and only confirms a trend has occurred after it has occurred. However, the EMA lags less than the SMA. You can find more about the types of indicators in the blog Top Technical Analysis Tools.
Q4. What are the most common time periods used for SMA and EMA?
A: A trader will generally use the longer time periods for longer-term trends. You will see traders using the 50-period, 100-period, and 200-period SMAs. A trader will use shorter time periods like the 9-period, 12-period, or 26-period EMAs for intraday trading and swing trading. The 26-period EMA is commonly used when measuring the Moving Average Convergence Divergence (MACD).
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