By now, you’re probably asking yourself, which is better?
The simple or the exponential moving average?
First, let’s start with the exponential moving average.
When you want a moving average that will respond to the price action rather quickly, then a short period EMA is the best way to go.
These can help you catch trends very early (more on this later), which will result in higher profit. In fact, the earlier you catch a trend, the longer you can ride it and rake in those profits (boo yeah!).
The downside to using the exponential moving average is that you might get faked out during consolidation periods (oh no!).
Because the moving average responds so quickly to the price, you might think a trend is forming when it could just be a price spike. This would be a case of the indicator being too fast for your own good.
With a simple moving average, the opposite is true.
When you want a moving average that is smoother and slower to respond to price action, then a longer period SMA is the best way to go.
This would work well when looking at longer time frames, as it could give you an idea of the overall trend.
Although it is slow to respond to the price action, it could possibly save you from many fake outs.
The downside is that it might delay you too long, and you might miss out on a good entry price or the trade altogether.
An easy analogy to remember the difference between the two is to think of a hare and a tortoise.
The tortoise is slow, like the SMA, so you might miss out on getting in on the trend early.
However, it has a hard shell to protect itself, and similarly, using SMAs would help you avoid getting caught up in fakeouts.
On the other hand, the hare is quick, like the EMA. It helps you catch the beginning of the trend but you run the risk of getting sidetracked by fakeouts (or naps if you’re a sleepy trader).
Below is a table to help you remember the pros and cons of each.
|PROS||Displays a smooth chart which eliminates most fakeouts.||Quick Moving and is good at showing recent price swings.|
|CONS||Slow-moving, which may cause a lag in buying and selling signals||More prone to cause fakeouts and give errant signals.|
So which one is better?
With moving averages in general, the longer the time period, the slower it is to react to price movement.
But with all else being equal, an EMA will track price more closely than an SMA .
Because of this, the exponential moving average is typically considered more appropriate for short-term trading.
The same attributes that make the EMA more suited for short-term trading limit its effectiveness when it comes to longer-term trading.
Since the EMA will move with price sooner than the SMA, it often gets whipsawed, making it less than ideal for triggering entries and exits on “slower” chart timeframes like daily (or longer).
The SMA, with its slower lag, tends to smooth price action over time, making it a good trend indicator, allowing to remain long when the price is above the SMA and short when the price is below the SMA.
So SMA or EMA? It’s really up to you to decide.
You don’t have to limit yourself to a single type of MA or a single instance of an MA.
Many traders plot several different moving averages to give them both sides of the story.
They might use a longer period simple moving average to find out what the overall trend is, and then use a shorter period exponential moving average to find a good time to enter a trade.
There are a number of trading strategies that are built around the use of moving averages. In the following lessons, we will teach you:
Time for recess! Go find a chart and start playing with some moving averages!
Try out different types and try experimenting with different periods. In time, you will find out which moving averages work best for you.