The Average Investor's Blog

A software developer view on the markets

EMA vs SMA: A Curious Observation

Posted by The Average Investor on Jul 1, 2010

Last month the S&P 500 closed below its 10 month Simple Moving Average (SMA). In a previous post, I stated that taking this position would have netted a gain of 18%.

The curious fact is that if one has used the Exponential Moving Average (EMA) instead of SMA, the last trade would have resulted in “only” a 9.8% gain! The reason is that the EMA would have entered the trade a month later. A picture is worth thousands of words:

S&P 500, EMA (blue) and SMA (red)

Notice how the SMA (red line) is cutting the price earlier than the EMA (blue line) after the these big drops – these are the earlier entries.

Why bother with EMA then? My research has convinced me to use the exponential moving average (EMA) instead of the simple moving average. It was just a mere coincidence that I used SMA back then. Thus, for the sake of these discussions, I’d want to correct myself. Here is the table for the last few trades of S&P 500 based on 10 month EMA:

Date In Price In Date Out Price Out Gain/Loss
2003-05-01 916.92 2005-05-02 1156.85 26.17%
2005-06-01 1191.50 2008-01-02 1467.97 23.20%
2009-08-03 990.22 2010-06-01 1087.30 9.80%

Three winning trades, but still, the total accumulated gain 70.67% is still less than the total accumulated gain for the same period using SMA – 74.33%, regardless that the latter has a losing trade besides the three winning! Let’s review the SMA trades:

Date In Price In Date Out Price Out Gain/Loss
2002-04-01 1147.39 2002-05-01 1076.92 -6.14%
2003-05-01 916.92 2004-08-01 1101.72 20.15%
2004-11-01 1130.20 2007-12-01 1479.63 30.92%
2009-07-01 920.82 2010-06-01 1089.41 18%

And I am still convinced to use EMA … Hmmm …

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