A question about moving averages that seems to weigh heavily on traders’ minds is whether to use the “simple” or “exponential” moving average. Regardless of the type you choose, the basic principle is that if there is more buying pressure than selling pressure, prices will move above the average and the market will be in an uptrend. On the other hand heavy selling pressure will make the prices drop below the moving average, indicating a downtrend.

The choice of moving average depends on various factors like your trading frequency, investing style and the stock which has been traded by you. The simple moving average obviously has a lag, but the exponential moving average may be prone to quicker breaks. Some traders prefer to use exponential moving averages for shorter time periods to capture changes quicker. Some investors prefer simple moving averages over long time periods to identify long-term trend changes. In addition, much will depend on the individual security in question. A 50- day SMA might work great for identifying support levels in INFOSYS but a 100-day EMA may work better for the ACC. Moving average type and length of time will depend greatly on the individual security and how it has reacted in the past.

The dilemma of an investor whether to select exponential moving average or simple moving average can be solved only by obtaining an optimum trade off between sensitivity and reliability. The more sensitive an indicator is the more signals that will be given. Although these signals may prove timely, but they are highly sensitive and may generate false signals. The less sensitive an indicator is the fewer signals that will be given by it. However, less sensitivity leads to fewer and more reliable signals. Sometimes these signals can be late as well.

Shorter moving averages are very sensitive and generate more signals. The EMA, which is generally more sensitive than the SMA, will also be likely to generate more signals. But along with it numbers of false signals are also high. Longer moving averages will move slower and generate fewer signals. These signals will likely prove more reliable, but they also may come late. Thus it requires every investor to experiment on different moving averages –lengths and their types to examine the trade-off between sensitivity and signal reliability.