What Difference between Simple Moving Average and Exponential Moving Average

We often heard of moving averages when we are talking about the stock market. What are moving averages?

Moving averages are used to the historical price data from a security to detect a upward or downward trend. Since their calculation is based on past data, they carries lag factor. Therefore, moving averages do not have predictive power.

The Simple Moving Average (SMA) and the Exponential Moving Average (EMA) are the most well-known.  The most common numbers of periods for moving averages are 5, 20, 50, and 200.  Traders and investors can choose the different numbers of periods based on their investment goals and trading patterns. Long-term inverstors tend to use the larger number of periods, likewise.

When the simple moving averages are calculated, each day’s price carries the same weight in the formula. However, the more weight is applied to recent prices when exponential moving averages are computed.

The following chart shows the 20-day simple moving averages and 20-day exponential moving averages for Dow Jones Industrial Average.

 

                        Source: Line Graph outline from StockCharts.com.  Actual data compiled by blogger.

 

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