Simple versus exponential moving averages, by now, you’re probably asking yourself, which is better?
The simple or the exponential moving average?
First, let’s start with the exponential moving average.
When you want a moving average that will respond to the price action rather quickly, then a short-period EMA is the best way to go.
These can help you catch trends very early (more on this later), which will result in higher profit. In fact, the earlier you catch a trend, the longer you can ride it and rake in those profits (boo yeah!).
The Downside of Exponential Moving Average
The downside to using the exponential moving average is that you might get faked out during consolidation periods (oh no!).
Because the moving average responds so quickly to the price, you might think a trend is forming when it could just be a price spike. This would be a case of the indicator being too fast for your own good.
Simple Moving Averages
With a simple moving average, the opposite is true.
When you want a moving average that is smoother and slower to respond to price action, then a longer period SMA is the best way to go.
This would work well when looking at longer time frames, as it could give you an idea of the overall trend.
Although it is slow to respond to the price action, it could possibly save you from many fake outs.
The downside is that it might delay you too long, and you might miss out on a good entry price or the trade altogether.
The Tortoise and Hare
An easy analogy to remember the difference between the two is to think of a hare and a tortoise.
The tortoise is slow, like the SMA, so you might miss out on getting in on the trend early.
However, it has a hard shell to protect itself, and similarly, using SMAs would help you avoid getting caught up in fake outs.
On the other hand, the hare is quick, like the EMA. It helps you catch the beginning of the trend but you run the risk of getting sidetracked by fake outs (or naps if you’re a sleepy trader).
Below is a table to help you remember the pros and cons of each.
|PROS||Displays a smooth chart that eliminates most fake outs.||Quick Moving and is good at showing recent price swings.|
|CONS||Slow-moving, which may cause a lag in buying and selling signals||More prone to cause fake outs and give errant signals.|