What Is The Difference Between EMA and SMA

Moving Averages are technical indicators used by most traders. They are commonly referred to as just moving averages; however, there’s more than one type. Moving averages consist of either a Simple Moving Average (SMA), or an Exponential Moving Average(EMA).

In this article, we are going to discuss the following:

• What Are Moving Averages
• What’s The Difference Between SMA & EMA
• When To Use Moving Averages
• What Moving Average Is Better For Day Trading

TG Watkins of Simpler Trading explains why each Moving Average has specific strengths and how traders use them to gain an edge in the market. 

Moving Averages are designed to “smooth” out stock prices over a specified time frame. The most common time frames for Moving Averages are 8, 21, 50, and 200 days. Modern charting software allows us to establish the number of days or use intraday periods for calculations. These periods and the 15-minute timeframe will be used for ease of understanding. 

Charts Show Price Trends

The EMA and the SMA moving averages appear somewhat differently when charted. Understanding why a similar calculation of averages can vary and their significance to your trade is essential.

Simple moving averages (SMA) give all historical stock prices equal weight, while exponential moving averages (EMA) put more weight into calculating recent stock prices. Moving averages shift the timeframe of the prices being calculated – with these key differences:

• Simple Moving Average (SMA) – The most commonly used moving average takes the sum of past closing prices over a set period of time and divides that number by the number of data or price points, resulting in a Simple Moving Average. 
• Exponential Moving Average (EMA) – The EMA gives more weight to the most recent prices or data points by adding a weighted multiplier into the equation. This keeps the moving average line close to the price changes on the chart.

What is a Simple Moving Average (SMA)?

A simple moving average allows you to select the number of days you want within your established time frame. The SMA is calculated by adding the closing price of a stock for a selected number of days and then dividing that by the number of days in the time frame. This gives the average price of that security for that time frame. A simple moving average makes assessing a security’s price trend easier. 

As we compare the two SMAs, each covering different periods of time, this allows traders to quickly identify uptrends and downtrends. When a shorter-term SMA is above a longer-term average, you can usually expect an uptrend. In contrast, when a long-term average above a shorter-term average usually signals a downtrend.

The death cross and golden cross are popular trading patterns that use simple moving averages. The death cross occurs when the 50-day SMA crosses below the 200-day MA. This is a bearish signal and can signify losses. The golden cross happens when a short-term MA moves above a long-term MA. When combined with high trading volumes, this can indicate gains are possible.

Exponential Moving Average Explained (EMA)

If SMA is a simple average, what is EMA? This slight change in the equation gives traders a narrower view of the current price changes.

When an SMA indicator line changes, it often reflects a past significant move in the market – meaning the optimal point of entry has passed. The exponential moving average calculation places more weight on the most recent data that is “hugging” the price action tightly with a quicker response. This makes this calculation more valuable as a trading entry signal.

When we consider the definition of a moving average is – it’s basically a trend-following or lagging indicator based on past prices. The real impact of this calculation variance is that it affects how we use moving averages when we use the charts. 

MA Shows Price Movement

When using the exponential moving averages for the current price, you’ll see more sensitivity to price changes. 

Using the 8-day EMA as an example, the eight-period takes the information from the last eight days and creates a data point. Each day you move forward, it takes the average from the previous eight days and keeps doing so as time progresses. That is why the eight-day EMA is closer to the current price than a 21-day EMA.

The 21-period EMA calculates price points for the past 21 days. This will result in a somewhat slower moving average. When using multiple EMAS on the same chart, such as the 8 or 21 period EMA, we can determine a trend based on where the EMA’s are in relation to eachother and the price of the underlying stock or security.

The 50-day and 200-day EMAs are used as long-term trends signals. Once the price of a stock crosses its 200-day moving average, it serves as a technical indicator that a reversal has happened. All moving averages used in technical analysis are lagging indicators. This means conclusions drawn from applying a moving average should be used to indicate its strength or confirm a market move.

As you can see in the chart above, the SMA on the left does not follow the price of TLSA as closely as the EMA on the right. 

Trading with the EMA and SMA

Using moving averages for trading can provide valuable information when identifying trends in the underlying stock. Because specific moving averages often serve as support or resistance levels, we can use them to determine the strength of a move in either direction. 

For instance, when the price of a stock rises above the 50-period simple moving average, this level may act as an area of support. The price will often bounce off this area until it no longer has strength. Once it moves below the 50-period SMA, this level becomes an area of resistance. The stock price may struggle to rise above the 50 SMA until it consolidates and gains strength or reverses and moves lower. These indicators are essential both on the hourly and daily timeframes. 

Since things change, you need to use an indicator or look at the timeframes to see when things change. If we’re looking at purely a price and a moving average concept to figure out when something has changed from resistance to support, it hasn’t been concluded yet. But, we begin to see that change.

Moving averages confirm whether a sell or buy signal is confirmed or supported by this technical indicator. In addition, the moving average is the basis for many other technical indicators and is a stock market indicator that can help traders make sense of price fluctuations.

Which MA is better for day trading?

EMAs are better suited for trending markets – when the market is in a strong upward trend. The EMA indicator will also indicate a downtrend when the market is in a downward trend. 

Day and swing traders look at the EMA line direction and the relationship between the rate change from one bar to the next. Should the price action of a solid uptrend begin to flatten and then reverse, the exponential moving average change rate from one bar to the next will also begin to diminish until the indicator line completely flattens and there is a zero rate of change.

If an EMA shows a strong upward trend on a daily chart, the strategy of an intraday trader may be to make long (buy) trades. Due to weighted calculations, traders may see variations between the simple moving average and the exponential moving average. The differences between the SMA and the EMA are most noticeable when comparing long-term averages.

The 200-day EMA responds faster to the most current price changes in indexes, including the S&P 500, compared to the SMA. However, the simple moving average (SMA) is a true indicator of the average price over a specific time frame. Because of this, many technical analysts prefer to use the SMA to identify resistance or support levels.

The simple moving average and exponential moving average are both used to measure stock trends and can smooth out price fluctuations for traders.

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