Moving averages are technical indicators traders can use to track stock prices over time. The basic idea is that looking at how a stock's average price has changed over a specific number of days can show you if it has been trending higher, lower or just moving sideways. You can also use moving averages to identify support and resistance levels.
Two common moving averages are simple moving averages (SMAs) and exponential moving averages (EMAs). Each has its strengths and weaknesses. Which one you use for a given trade will depend on your strategy.
A simple moving average is just what it sounds like: a straightforward calculation of a stock’s average price—usually, its closing price—over a set number of days. So, if you’re looking at a 10-day moving average, you just add up the stock’s last 10 closing prices and then divide that number by 10. And because this is a moving average, as each day passes you add a new closing price as an old one drops off.
As you might have noticed, SMA is a backward-looking indicator insofar as it gives equal weight to a 10-day old closing price as it does yesterday’s closing price. As a result, a stock’s SMA might not react as quickly to recent events.
That’s where exponential moving averages come in. EMAs attempt to correct for the lag time of an SMA by giving more weight to recent price moves than older ones. Unfortunately, because of the weighting, EMA is a more complex calculation, but most trading platforms do it automatically.
So how do you choose when to use an SMA or an EMA? That will depend on your strategy.
For example, if your strategy is to buy a stock when the slope of its moving average starts to turn upward, potentially indicating a rising trend, or sell when the slope turns down, EMA might be a better choice because it favors more recent price moves and it can give you a quicker signal about a potential trend.
One tradeoff, though, is that traders who use EMAs to join trends are more prone to getting whipsawed. Whipsaws occur when a security starts moving in one direction but then quickly reverses and moves briefly in the opposite direction. For trend-following traders, whipsaws can sometimes lead to a series of losing trades.
Traders who use SMAs tend to experience fewer whipsaws, though they might be slower when it comes to spotting trends.
You can also use moving averages to identify support and resistance levels.
Technically, you can use either SMAs or EMAs for that, but many traders prefer SMAs, which generally make it a more effective indicator, as conventions like this can help shape trends if enough traders follow them.
Both SMAs and EMAs can be useful tools for traders who like to follow trends. Which type you choose often comes down to personal preference. Try experimenting with both types and see which best fits your personal trading style.
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