From afar, it would appear that the difference between an exponential moving average and a simple moving average is minimal. For this example, which uses only 20 trading days, the difference is minimal, but a difference nonetheless. The exponential moving average is consistently closer to the actual price. On average, the EMA is 3/8 of a point closer to the actual price than the SMA.


From day 10 to day 20, the EMA was closer to the price than the SMA 8 out of 11 times. The average absolute difference between the exponential moving average and the current price was 1.52 and the simple moving average had an average absolute difference of 1.69. This means that on average, the exponential moving average was 1.52 point above or below the current price and the simple moving average was 1.69 points above or below the current price.


A comparison of a 50-day EMA and a 50-day SMA for IBM also shows that the EMA picks up on the trend quicker than the SMA. The blue arrows mark points when the stock started a strong trend. By giving more weight to recent prices, the EMA reacted quicker than the SMA and remained closer to the actual price. The gray circle shows when the trend began to slow and a trading range developed. When the change from trend to trading began, the SMA was closer to the price. As the trading range continued into 2001, both moving averages converged. In early 2001, CPQ started to trend up and the EMA was quicker to pick up on the recent price change and remain closer to the price.



Which is best, simple or exponential?

Which moving average you use will depend on your trading and investing style and preferences. The simple moving average obviously has a lag, but the exponential moving average may be prone to quicker breaks. Some traders prefer to use exponential moving averages for shorter time periods to capture changes quicker. Some investors prefer simple moving averages over long time periods to identify long-term trend changes. In addition, much will depend on the individual security in question. A 50-day SMA might work great for identifying support levels in the NASDAQ, but a 100-day EMA may work better for the Dow Transports. Moving average type and length of time will depend greatly on the individual security and how it has reacted in the past.


The initial thought for some is that greater sensitivity and quicker signals are bound to be beneficial. This is not always true and brings up a great dilemma for the technical analyst: the trade off between sensitivity and reliability. The more sensitive an indicator is, the more signals that will be given. These signals may prove timely, but with increased sensitivity comes an increase in false signals. The less sensitive an indicator is, the fewer signals that will be given. However, less sensitivity leads to fewer and more reliable signals. Sometimes these signals can be late as well.


For moving averages, the same dilemma applies. Shorter moving averages will be more sensitive and generate more signals. The EMA, which is generally more sensitive than the SMA, will also be likely to generate more signals. However, there will also be an increase in the number of false signals and whipsaws. Longer moving averages will move slower and generate fewer signals. These signals will likely prove more reliable, but they also may come late. Each investor or trader should experiment with different moving average lengths and types to examine the trade-off between sensitivity and signal reliability.