A simple moving average (SMA) is a chart indicator that helps traders see trends and identify key price points for a stock, commodity, forex pair, exchange traded fund, or futures contract. The indicator is computed as an average of prices over a specific period of time, such as 20, 50, or 200 days. Critics argue that a simple average gives too much weight to old data, which are deemed to be less significant. Therefore, many traders prefer to use an exponential moving average (EMA) instead.
Key Takeaways
- A simple moving average is a chart indicator that is computed as the average of closing prices over a period of days, like 50 or 200 days.
- Some traders believe that a simple moving average gives too much weight to old data and prefer to use an exponential moving average instead.
- SMAs and EMAs are used in similar ways: to identify trends and find potential areas of support or resistance.
- An advantage of the SMA is that is smooth, but a disadvantage is that it might not accurately reflect the most recent trends.
SMA vs. EMA
The SMA is a straightforward calculation because the indicator is simply the average price over a chosen time period. For example, if a stock closes at $50, $51, and $52 over three days, the three-day moving average is plotted at $51 per share. As each new day is added, an old one drops off.
A simple moving average provides insight into trends and potential support or resistance areas. The SMA typically trends higher when prices move up and lower as prices turn to the downside. In an uptrend, a simple moving average often appears below price and, when price falls toward the SMA (but not below it), the average identifies a potential area of support. On the other hand, when the simple moving average is above price in a downtrend, the SMA slopes downward and sometimes appears as an area of resistance.
In contrast to the simple moving average, the exponential moving average is computed in a manner that gives greater weighting to the most recent days. That is, the EMA takes a simple moving average and uses a multiplier so that more recent data is assigned more importance. The calculation typically follows the formula: [2 ÷ (selected time period + 1)]. For example, the multiplier on a 20-day moving average is [2/(20+1)]= 0.0952.
Advantages and Disadvantages
The main advantage of the SMA is that it offers a smoothed line, less prone to whipsawing up and down in response to slight, temporary price swings back and forth. The SMA's weakness is that it is slower to respond to rapid price changes that often occur at market reversalpoints. The SMA is often favored by traders or analysts operating on longer time frames, such as daily or weekly charts.
The advantage of the exponential moving average is that by being weighted to the most recent price changes, it responds more quickly to price changes than the SMA does. This is particularly helpful to traders attempting to trade intraday swing highs and lows since the EMA signals trend change more rapidly than the SMA does.
The concurrent disadvantage of the greater sensitivity of the EMA is that it is more vulnerable to false signals and getting whipsawed back and forth. The EMA is commonly used by intraday traders who are trading on shorter time frames, such as the 15-minute or hourly charts.
The Bottom Line
The advantage of the simple moving average is that the indicator is smoothed and, compared to the EMA, less prone to a lot of false signals. The drawback is that some of the data used to compute the moving average might be old or stale. Nevertheless, the EMA and SMA are used in similar ways: to see trends and identify areas of support or resistance. Since neither average is inherently superior, the question of which one to use is typically settled by the user's trading style or analytical frame of reference.
FAQs
The main advantage of the SMA is that it offers a smoothed line, less prone to whipsawing up and down in response to slight, temporary price swings back and forth. The SMA's weakness is that it is slower to respond to rapid price changes that often occur at market reversal points.
What is the primary disadvantage of the moving average method? ›
The main disadvantage of moving average forecasts is the need to maintain all individual data elements.
What are the advantages of moving average in statistics? ›
Some of the advantages of using moving averages include: Moving average is used for forecasting goods or commodities with constant demand, where there is a slight trend or seasonality. Moving average is useful for separating out random variations. Moving average can help you identify areas of support and resistance.
What is the weakness of moving average? ›
Moving averages are lagging indicators, do not work well in volatile markets, are not suitable for short-term trading, and may not work for certain types of stocks. Therefore, investors should use moving averages in conjunction with other technical analysis tools to make informed investment decisions.
What is the problem with simple moving average? ›
Drawbacks of simple moving average forecasts
Less preferable for quick price increases: Simple moving average forecasts look at stock price trends overtime. Because of this, professionals typically don't use this type of moving average when they want to analyze price trends for industries with high price fluctuations.
What are the disadvantages of SMA? ›
The SMA's weakness is that it is slower to respond to rapid price changes that often occur at market reversal points. The SMA is often favored by traders or analysts operating on longer time frames, such as daily or weekly charts.
What are the advantages of simple average method? ›
Advantages Of Simple Average Method
1. Simple average method is very suitable when materials are received in uniform lot quantities. 2. Simple average method is very easy to operate.
Why do we use simple moving average? ›
The SMA, with its built-in lag, tends to smooth price action over time, making it a good trend indicator—staying long when price is above the average and flat (or short) when it's below. A simple moving average can also be effective as a support and resistance indicator.
What is the advantage and disadvantage of average? ›
For each average type, the key merits include things like being unaffected by outliers, ease of calculation or interpretation. Key demerits include being affected by outliers, difficulty in calculation, or not representing the actual data values.
What are the advantages and disadvantages of weighted moving average method? ›
One advantage is its responsiveness to recent data points, which makes it useful for short-term trading strategies. On the other hand, one disadvantage is its sensitivity to outliers or sudden price movements.
A moving average helps to smooth price action and filter out noise in the data. It is used to identify trend direction, define potential support and resistance levels, and serves as a building block for many other technical indicators.
What are the disadvantages of exponential moving average? ›
However, a key drawback of the exponential moving average is that it is based on historical data, so it cannot predict future price movements. Furthermore, the EMA can also be prone to false signals, such as false positives and false negatives, meaning that it could mislead traders.
Why is the moving average the best? ›
The moving average helps to level the price data over a specified period by creating a constantly updated average price. A simple moving average (SMA) is a calculation that takes the arithmetic mean of a given set of prices over a specific number of days in the past.
What is the primary advantage of the simple moving average methods? ›
Merits of Moving Average Method
Moving averages help in identifying the trends. This allows the traders to avail of and understand the trends established in the market. It also acts as a support system as it helps in determining potential price support. It provides the support to measure the momentum as well.
Is simple moving average positive or negative? ›
The SMA signal receives two values, either positive when the shorter-term SMA is above the Longer-term or negative when the shorter-term SMA is below the longer term.
What is the difference between simple moving average and moving average? ›
Description. Exponential Moving Average (EMA) is similar to Simple Moving Average (SMA), measuring trend direction over a period of time. However, whereas SMA simply calculates an average of price data, EMA applies more weight to data that is more current.
What is the primary disadvantage of moving average methods in Quizlet? ›
Shortcomings in Moving Average Methods. primary one: they do not react well to variations due to trend or seasonality because they are considered smoothing methods.
What is the primary disadvantage of moving average methods in Chegg? ›
Which of the following is / are disadvantages of the moving average forecast? It is difficult to compute. Random variations are smoothened out, making structural patterns less evident.
What are the disadvantages of moving average filter? ›
The disadvantage of these filters is that they must use convolution, a terribly slow algorithm. number of points in the moving average (an odd number). Before this equation can be used, the first point in the signal must be calculated using a standard summation.
What are the disadvantages of EMA? ›
Limitations of EMA
It is more time consuming for the research subject than meeting with a clinician at intervals. Another disadvantage of EMA, as with all self-report measures, is that there is no independent check on the veracity of the data, because all data are collected in the absence of the experimenter.
