The stock market comes with a unique language, filled with terminology that can leave a novice trader feeling overwhelmed. One such term is the Moving Average, which serves as an essential tool used by many traders to identify potential market entry and exit points. Moving Averages come in two forms, Exponential and Simple, that have different meanings, uses, and implications.
The Simple Moving Average (SMA) is a simple tool that is a straightforward calculation of the average closing price of a security over a fixed number of time periods, with the original data points being equally weighted. Put more simply, it calculates the average price of a certain stock over a peroid of time specified by the user. For example, a 10-day SMA reveals the average closing price over the 10 day period.
The Exponential Moving Average (EMA) is similar to the SMA, but with an emphasis put on more recent data than older data. This tool helps smooth out the asset’s price over a given period of time, and places a greater emphasis on recent price movements, allowing traders to quickly identify trends in the market. Unlike the SMA, which gives the same weight to all data points, the EMA puts greater weight on the most recent data points.
In the end, which tool is best is completely up to the individual trader. The main difference between the two is that the SMA is more reliable for longer term analysis while the EMA is appropriate for shorter-term analysis and trend identification. For example, a swing trader may choose to use the EMA as their primary tool for stock analysis, where a long-term investor may be more likely to use an SMA.
In conclusion, Simple Moving Averages and Exponential Moving Averages are two popular tools used by traders to analyze trends and gain an edge in the market. Their ability to provide quick insight into market trends and trading opportunities make them essential tools for the investor. However, the main factor is which tool to use and when to use it – a decision that should solely be made by the individual trader.