Moving averages (SMA, EMA)

You can explain how simple and exponential moving averages are calculated, what they show about the trend and why crossovers come late.

Direction under the noise

Every chart is noisy. Prices jump up and down from one candle to the next, and it can be hard to see the larger direction under all the wiggles.

A moving average is the oldest and most widely used tool for smoothing that noise. It appears on almost every trading platform, in many trading systems and in countless headlines about shares "breaking below their 200-day average". It is simple, useful, and always a little late.

Average of recent closes

A moving average is the average of the last few closing prices, recalculated with every new candle. Each new close is added and the oldest one dropped, so the average moves along with the chart.

The simple moving average, or SMA, weights all closes in the window equally. A 20-period SMA is the sum of the last 20 closes divided by 20.
The exponential moving average, or EMA, gives more weight to recent closes. It reacts faster to new prices and turns sooner than an SMA of the same length.

How traders use them:

Direction. A rising average describes an uptrend, a falling average a downtrend.
Position. Price above a rising average is often read as strength, price below a falling one as weakness.
Crossovers. A moving average crossover happens when a shorter average crosses a longer one. A cross of the 50-day above the 200-day average is often called a golden cross, the opposite a death cross.

Length matters. As StockCharts' guide explains, short averages hug the price and turn quickly, long averages move slowly and lag more. A 20-period average on a daily chart covers about a month, on an hourly chart less than a day.

All moving averages share one property: they are built from past prices. They describe where the price has been, which means they always lag behind turns. The lesson on why indicators lag looks at this in detail.

Nine candles late

The fictional chart shows a decline from 110 to a low of 96.51 on candle 24, followed by a rise to 114. The gold line is the 20-period SMA, the lighter line the 10-period SMA.

The price closes above the 20-period average on candle 30, at 100.18, six candles after the low.
The 10-period average crosses above the 20-period average on candle 33. By then, the price is at 101.97, about 5.5 points above the low.
Both averages then rise with the trend, and the price stays above them most of the way to 114.

The crossover was correct about the new direction. But a trader waiting for it missed the first third of the move from the low. That is the price of confirmation, and in sideways markets, where averages cross back and forth, it buys many false signals too.

Common mistakes

Treating a crossover as a prediction. It confirms a turn that already happened.
Using crossovers in ranges. They produce repeated false signals there.
Optimizing the length. The "best" period on past data rarely stays the best.
Forgetting the timeframe. The same period means very different spans on different charts.

The takeaway

A moving average smooths prices into a line. The EMA reacts faster than the SMA. Both lag, so crossovers confirm turns after they happen.

Check yourself

Quick quiz

4 questions. Instant feedback, nothing is saved.

1Tap the candle at which the 10-period average crossed above the 20-period average.

Tap the chart.

On candle 33, the 10-period SMA (99.41) moved above the 20-period SMA (99.23), nine candles after the low at 96.51.
2How is a 10-period simple moving average calculated?

Each new candle adds the newest close and drops the oldest. That is why the line moves.
3What is the main difference between an SMA and an EMA of the same length?

Both smooth the price, but the exponential average gives more weight to recent closes and turns sooner.
4Why do moving average crossovers come late?

Moving averages describe where the price has been. A crossover confirms a turn that is already under way.

of 4 correct.

Sources

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