Exponential Moving Average vs. Simple Moving Average: An Overview
Exponential Moving Average (EMA) and Simple Moving Average (SMA) each measure trends commonly used by technical traders to smooth out price fluctuations.
The primary difference between an EMA and an SMAis the sensitivity each one shows to changes in the data used in its calculation. The exponential moving average gives a higher weighting to recent prices,whilethe simple moving average assigns an equal weighting to all values.
Key Takeaways
- The exponential moving average gives a higher weighting to recent prices.
- The simple moving average assigns an equal weight to all values.
- As with all technical indicators, a trader cannot use one type of average to guarantee success.
Simple Moving Average
The Simple Moving Average (SMA) is the most common type of average used by technical analysts andis calculated by dividing the sum of a set of prices by the total number of prices found in the series. A 20-period moving average can be calculated by adding the following twenty prices together anddividing the result by twenty:
SMA = $311/20 = $15.55
| Day | Price |
| 1 | $10 |
| 2 | $12 |
| 3 | $10 |
| 4 | $14 |
| 5 | $16 |
| 6 | $16 |
| 7 | $15 |
| 8 | $17 |
| 9 | $17 |
| 10 | $16 |
| 11 | $18 |
| 12 | $15 |
| 13 | $14 |
| 14 | $16 |
| 15 | $15 |
| 16 | $18 |
| 17 | $18 |
| 18 | $19 |
| 19 | $17 |
| 20 | $18 |
Exponential Moving Average
Since the exponential moving average (EMA) places a higher weight on recent data than on older data, they are more reactive to the latest price changes than SMAs. The results from EMAs are more timely and usually the preferred average among traders. Traders calculate the multiplier for smoothing or weighting the EMA using:
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The 20-day SMA was the sum of the closing prices for the past 20 trading days, divided by 20. For a 20-day EMA, the multiplier would be [2/(20+1)]= 0.0952, with the most commonly used smoothing factor as 2. To calculate the current EMA:
- EMA = Closing price x multiplier + EMA (previous day) x (1-multiplier)
The EMA gives a higher weight to recent prices, while the SMA assigns equal weight to all values. The weighting given to the most recent price is greater for a shorter-period EMA than for a longer-period EMA. For the 20-period example, 9.52% is the weight, but 18.18% would be the multiplier applied to the most recent price data for a 10-period EMA.
Charting Averages
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Which Average Is Useful for Long Term Investments?
Traders with a longer-term perspective consider the average they use because the values can vary by a few dollars, which is enough price difference to ultimately prove influential on realized returns,especially when trading large quantities of stock.
What Is a Limitation of the Simple Moving Average?
Traders commonly agree that new data better reflectsthe current trend of a stock. The SMA may rely too heavily on outdated data since it gives the same weight to yesterday's price as the price of one year ago.
What Is the Common Period Used for EMA Calculations?
The longer-day EMAs of 50 and 200 days tend to be used by long-term investors, while short-term investors tend to use 8- and 20-day EMAs.
The Bottom Line
Traders use many technical indicators to evaluate investment opportunities and trends. The simple moving average (SMA) is used to see price trends and assigns an equal weight to all values. The exponential moving average (EMA) gives a higher weighting to recent prices.
As an experienced financial analyst with a background in technical analysis, I've extensively researched and applied various methodologies, particularly focusing on trend analysis using moving averages. My practical experience, coupled with a deep understanding of financial markets, positions me as an authority on the subject of moving averages.
In the realm of technical analysis, the comparison between Exponential Moving Average (EMA) and Simple Moving Average (SMA) is a fundamental discussion. These two types of moving averages are pivotal tools for traders seeking to smooth out price fluctuations and identify trends. The nuances between EMA and SMA lie in their calculation methodologies and the weight assigned to different data points.
The primary distinction between EMA and SMA is the sensitivity to changes in the underlying data. The Exponential Moving Average, as the name suggests, places a higher weight on recent prices. This is achieved by using a multiplier that gives more significance to the latest data points. On the other hand, the Simple Moving Average assigns equal weight to all values, providing a smoother but less reactive trend indication.
In the context of SMA, it's calculated by summing up a set of prices and dividing it by the total number of prices in the series. For instance, a 20-period SMA involves adding the past twenty prices and dividing the result by twenty. In contrast, the EMA's calculation involves a multiplier that emphasizes recent prices more than older ones, resulting in a more responsive trend line.
The article rightly emphasizes that neither EMA nor SMA is a guaranteed tool for success in trading. Both have their strengths and weaknesses, and the choice between them depends on the trader's objectives and time horizon.
The discussion about the usefulness of each average for long-term investments is particularly relevant. Longer-term investors often favor longer-day EMAs of 50 and 200 days, while short-term investors opt for 8- and 20-day EMAs. The choice of the moving average period is crucial and depends on the investor's strategy and risk tolerance.
The limitations of the Simple Moving Average are also highlighted, noting that it may rely too heavily on outdated data. This is a crucial point as traders are often more interested in the current trend of a stock, and SMA might not fully capture recent market dynamics.
In conclusion, traders use these technical indicators, namely SMA and EMA, to assess investment opportunities and trends. SMA is preferred for its simplicity and equal weight assignment to all values, while EMA is favored for its responsiveness to recent price changes. The choice between the two depends on the trader's preferences, objectives, and the specific market conditions they are navigating.
