Exponential moving averages vs. simple moving averages
If you want the moving average to have a fast price reaction, the best will be an exponential moving average for a short period. A short period EMA helps us find trends early that may lead to higher profits and gains. The earlier you catch trends, the longer you can take advantage of those profits. However, the only issue about exponential moving averages is the chance of getting faked out on consolidation periods. Why? Since the EMA’s reaction to the price is fast and quick, you may think that a trend formed, but it is just a price spike in reality. The indicator was too fast. The total opposite of the EMA is the SMA, also known as the simple moving averages.
There is a famous saying that goes: “slowly but surely.” This is the perfect description for the simple moving average. If you want a moving average with a smoother and slower reaction to the price, then the best would be an SMA with a longer period. This moving average is very effective when it comes to looking at longer time frames. It helps us visualize what the overall trend looks like. Yes, indeed, they take longer to respond to the price action, but you will be safe from being faked out, thinking there is a new trend, but there is none in reality. However, of course, the issue with this moving average would be the long delay. And when we say delay, this could also mean that you can miss a good entry price opportunity — the whole trade even.
Let us list down SMA’s advantages and disadvantages:
- Benefits: The chart display is smooth, and it eliminates the possibility of being faked out.
- Disadvantages: Since it is slow, you might miss out on great buy and sell opportunities.
Let us list down EMA’s advantages and disadvantages:
- Advantages: The fast reaction to the price makes us see the most recent price swings.
- Disadvantages: They might lead you to fake-outs since they are so fast. You might mistake it for a wrong signal.
So, which is better between SMA and EMA?
Nothing is better than the other. Why? You should use the one that is best for your situation. Let us repeat that the longer the time frame, the slower the reaction. The shorter the time frame, the faster is the reaction. If everything else was equal, then we can say that EMA tracks price closer than SMA. Due to this reason, if you want to participate in only short-term trading, then EMA might be more appropriate. However, its strength in short-term trading is not too adequate on long-term trading. It is not ideal when we trigger entries and exits on charts with slower timeframes like the daily, weekly, or longer ones.
On the other hand, SMA is the slower one, but it indeed smoothens our price action as time goes. It is a great indicator. It also stays long if the price is above the SMA, while it’s short if it is below.
If you are still confused
If you are contemplating whether to use SMA or EMA, you can always plot more than one moving average to understand better. You can use a long SMA to know the overall trend and a short EMA to know a good price trade entry. Do not limit yourself!