Understanding Exponential Moving Average vs. Simple Moving Average

Exponential Moving Average vs. Simple Moving Average: An Overview

Exponential Moving Average (EMA) and Simple Moving Average (SMA) are similar in that they each measure trends. The two averages are also similar because they are interpreted in the same manner and are both commonly used by technical traders to smooth out price fluctuations.

There are some differences between the two measurements, however. The primary difference between an EMA and an SMA is the sensitivity each one shows to changes in the data used in its calculation.

SMA calculates the average of price data, while EMA gives more weight to current data. The newest price data will impact the moving average more, with older price data having a lesser impact.

More specifically, the exponential moving average gives a higher weighting to recent prices, while the simple moving average assigns equal weighting to all values.

Exponential Moving Average

Since EMAs place a higher weight 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 shown in the example 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.

As with all technical indicators, there is no one type of average a trader can use to guarantee success.

Simple Moving Average

The SMA is the most common type of average used by technical analysts and 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 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