What is the difference between a simple moving average and an exponential moving average?

By Casey Murphy AAA
A:

The only difference between these two types of moving average is the sensitivity each one shows to changes in the data used in its calculation.

More specifically, the exponential moving average (EMA) gives a higher weighting to recent prices than the simple moving average (SMA) does, while the SMA assigns equal weighting to all values. The two averages are similar because they are interpreted in the same manner and are both commonly used by technical traders to smooth out price fluctuations.

The SMA is the most common type of average used by technical analysts and it is calculated by dividing the sum of a set of prices by the total number of prices found in the series. For example, a seven-period moving average can be calculated by adding the following seven prices together and then dividing the result by seven (the result is also known as an arithmetic mean average).

Example
Given the following series of prices:
$10, $11, $12, $16, $17, $19, $20
The SMA calculation would look like this:
$10+$11+$12+$16+$17+$19+$20 = $105
7-period SMA = $105/7 = 15

Since EMAs place a higher weighting on recent data than on older data, they are more reactive to the latest price changes than SMAs are, which makes the results from EMAs more timely and explains why the EMA is the preferred average among many traders. As you can see from the chart below, traders with a short-term perspective may not care about which average is used, since the difference between the two averages is usually a matter of mere cents. On the other hand, traders with a longer-term perspective should give more consideration to the average they use because the values can vary by a few dollars, which is enough of a price difference to ultimately prove influential on realized returns - especially when you are trading a large quantity of stock.

EMAvsSMA.gif

As with all technical indicators, there is no one type of average that a trader can use to guarantee success, but by using trial and error you can undoubtedly improve your comfort level with all types of indicators and, as a result, increase your odds of making wise trading decisions.

To learn more about moving averages, see Basics Of Moving Averages and Basics Of Weighted Moving Averages.

RELATED FAQS

  1. What are the best technical indicators that complement the Relative Vigor Index (RVI)?

    Discover some of the best technical indicators that traders and analysts can employ to supplement the use of the relative ...
  2. What are the best technical indicators that complement the Relative Strength Index ...

    Learn some of the best additional technical indicators that can be used along with the relative strength index to anticipate ...
  3. What is a common strategy traders implement when using the Relative Strength Index ...

    Read about some of the many uses of the Relative Strength Index (RSI), and learn about basic strategies traders implement ...
  4. How are Rising Three Methods patterns interpreted by analysts and traders?

    Understand the basics of the rising three methods candlestick pattern and how this strong continuation signal is interpreted ...
RELATED TERMS
  1. Intraday Momentum Index (IMI)

    A technical indicator that combines aspects of candlestick analysis ...
  2. Forex Spread Betting

    A category of spread betting that involves taking a bet on the ...
  3. Mass Index

    A form of technical analysis that looks at the range between ...
  4. Money Flow Index - MFI

    A momentum indicator that uses a stock’s price and volume to ...
  5. On-Balance Volume (OBV)

    A momentum indicator that uses volume flow to predict changes ...
  6. Negative Volume Index - NVI

    A technical indicator that relies on changes in a security’s ...

You May Also Like

Related Articles
  1. Trading Strategies

    Rise and Shine With This Pre-Market ...

  2. Active Trading Fundamentals

    Minute-to-Minute Trade Signals for Today's ...

  3. Investing

    How to Short Alibaba

  4. Technical Indicators

    Organize Price-Band Relationships In ...

  5. Trading Strategies

    Risk Management Techniques For Shorting ...

Trading Center