Moving Averages; SMA & EMA Explained

Last Updated on January 15, 2019 by Zion Miller

Overview

We have recently begun releasing educational pieces on technical strategies. The most recent article covering RSI got us thinking about other useful indicators for the less seasoned investors.

In this article we will discuss moving averages, focusing on EMA & SMA (Simple Moving Averages and Exponential Moving Averages).

Background

Moving averages generally  speaking can be broken down to smoothing a stock into a general direction. Although moving averages smooth the chart and price data into a general direction, they lack behind some indicators as they rely on past price data. Although this is often perceived as a flaw of their potential, they serve crucial roles in other indicators such as MACD and McClellan Oscillator.

So why should I care about EMA & SMA? The answer is this: They can assist spotting trend reversals and can  help identify resistance levels.

How is it calculated?

SMA is simple to calculate. It can be found by simply taking the price over several days, adding the closing prices, and dividing by the number of days. For example:

As you can see, a variance in price may lead to the SMA lagging behind.

EMA addresses the lagging issue by weighting recent prices. The drawback is you need in excess of 10 day data to calculate an accurate 10 day EMA. A 10 period EMA thus applies an 18.18% weight to recent prices. As the period grows, the weight decreases. The calculations below detail the processes for  finding the EMA and also how you may calculate this with a certain % in mind.

It is important to note that the more data you use in EMA, the more accurate your calculations will be. Conversely the more data (length of time) used in calculation of SMA, the larger the lag on moving averages. A short moving average is agile where as a longer average  takes longer to adapt to a stock’s volatility.

What The Look Like

Is One Better Than the Other?

Really neither one is  superior. Because of their distinct qualities they are are used for different strategies. EMA having less lag allows the result to be more responsive of short term fluctuations. In contrast SMA provides a clear average and is often argued to leave investors with a clear indication of potential support or resistance levels.

When considering which one to use in your strategy take timeframe is the crucial factor. MS feels it’s best to play around with both methods; and learn to use them in conjunction with other technical tools like RSI. The key takeaways from moving averages is; a rising moving average indicates that share price will increase and vice versa. This remains true for longer when a longer period is taken into account.

Moving averages additionally assist in investments with the story they often tell when a “crossover” occurs. A “golden crossover” (bullish crossover) is witnessed when a shorter term moving average crosses above a longer term moving average. Conversely the bearish/opposite (short term crosses under a long term MA) is known as a dead cross.

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