The Simple Moving Average (SMA) technical indicator determines its values by calculating the average price of an asset over a selected number of periods. The closing prices of the selected periods are most often used to achieve this objective. For example, a 10-day SMA is evaluated by adding the closing prices of the last 10 days and dividing the total by 10.
The diagram below displays the simple moving average as a green line. The main feature about the SMA is that it is a lagging indicator and will always trail price.
You should confirm this feature from studying the chart below by noticing that price always changes direction quicker than the SMA.
This is why the SMA is classified as a trend following indicator.
This attribute implies that the SMA performs well when price is trending but is less effective when price is range-bound.
To counter this problem, the Exponential Moving Average (EMA) was devised that is also referred to as the exponentially weighted moving average. The main feature of the EMA is that it minimizes lag by placing increased emphasize on more current prices in preference to older ones.
This weighting factor is dependent on the selected period of the EMA. This means that if you utilize a shorter EMA period, then increased weight will be applied onto the most recent prices. For example, a 20-period EMA emphasizes its current price by 9.52% while a 10-period EMA weighs it by 18.18%. Consequently, the EMA (blue line) reacts quickly to new price movements than the SMA (green line), as illustrated by the above chart.
Although the EMA stresses its most recent prices, it still calculates its values using its full data set including its older readings.
This feature infers that although the influences of older data reduce over time, they never fully disappear. Experts recommend utilizing the EMA with shorter time-frames while deploying the SMA will longer ones.
Whereas the SMA lags price, the EMA is able to respond faster to price movements. However, this feature can cause the EMA to generate more false signals. As such, although the EMA is able to produce more trading opportunities than the SMA, they can be of inferior quality.
In contrast, whereas the SMA identifies new trading opportunities later then the EMA, it generates fewer false readings. Consequently, although the SMA can cause you to execute new positions later than the ideal, it is considered to be more stable than the EMA.
You will need to conduct extensive testing using both indicators to determine which of them complies best with your trading objectives and aspirations.