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Which is better, a simple moving average or an exponential moving average?

The question rather begs another question - what does the word better mean? The answer is very much in the eye of the beholder.

The argument over simple and exponential moving averages has been around a long time and I doubt it will ever be resolved because each side makes different value judgements about what the word better means for them. So, I guess it depends what you are looking for.

The problem with a simple moving average: If you get a sudden shift in prices, it immediately affects the moving average. This is generally desirable, because it makes the moving average responsive to changes in the price. It is especially valuable for short term traders. However, where the problem comes in as that the sudden shift in prices also affects the moving average as it \d\r\o\ps out of the sample period. This is not desirable, especially for short term traders, because now the moving average is responding to something that happened in the past. This suggests that the exponential moving average might be better, because the sudden shift in prices in the past gradually decays in importance over time. This argument has been put very eloquently by Dr Alexander Elder in his books Trading for a Living and Come into my Trading Room.

The problem with exponential moving averages: If you get a sudden shift in prices, it immediately affects the moving average, like the simple moving average was affected, only it is somewhat more affected, because recent data has greater weighting in the calculation. This is generally desirable and especially for short term traders. However, the problem is that the sudden shift in prices never completely leaves the moving average. It persists for a long time. So, if there is a rogue event, however you define that, it stays in there for quite a while. This is not desirable in that you want the moving average to reflect what is happening now. This is especially important for short term traders. This argument has been put by Tom Demark in one of his videotapes and maybe elsewhere.

My own feeling is that it does not matter much which you use. My focus is on the longer term. I use a 260-day moving average and I don't think it makes much difference which one you use. I use the simple moving average for convenience.

However, in saying this, I have to warn you that I use the moving average only to help me see trend direction. I do not trade the crossovers of the moving average line as such.

I also have to warn you that my view might be different if I was a short term trader. In that case, I think that I would side with the exponential moving average on balance because it is more responsive to recent data and is not going to be jerked around by data leaving the look-back period.

However, I think I would be careful with it if there had been a piece of rogue data come through. Once it had left the period of the average, it might be prudent to watch the simple moving average as well for a while. This just goes to show that there are rarely one-size-fits-all answers in this game if something unusual happens. You have to keep thinking.