Which moving average do I use — exponential or simple? (July 11, 2014)
I want to look at Dow Chemical ( NYSE:DOW ), but just in one specific way. One of our members asked, “Why are you using the simple moving average relative to the exponential moving average?” I think there have been times in the past where I’ve used the EMA, the exponential moving average, so what I’ve done is just put them both here. This is a simple moving average; this is the exponential moving average.
What’s really important to know is, frankly there’s not that much difference between the two, simply because stocks don’t trade so technically that there’s kind of a magical moving average where the stock will specifically bounce off of one moving average. Like, “Oh, when I use the exponential that always works, or when I use the simple that always works.” You can put them together, you can create 10-day, 20-day, 30-day, 40-day, 50-day, 100-day, 150-day, and 200- day moving averages and create a matrix or a ribbon or whatever to show where the stock is trading within that moving average matrix. But as it relates to the 50-day moving average there’s really not that much difference, so you can take your pick.
If you look at the 200-day moving average, again, there’s just not that much difference. When I was younger I used to really have a specific moving average that I really wanted to use. I looked at the 50-day and the 200-day moving averages as being important to have a little lead-time, in other words, give me a better indication as to what the trend is right now verses just the simple average over the last 50-days or the simple average over the last 200-days. But as my trading experience has increased, to be perfectly honest with you, it doesn’t really matter that much, it really just doesn’t matter that much.
You look here at the exponential 200-day moving average verses the simple moving average and they’re both moving really well, just right in sync with each other. Here’s just one thing to keep in mind, but frankly I don’t know how you’re going to use it; when a stock is trending higher, so prices are higher with each data point, with each closing price, the average price over the last 200, or 100 or 50-days tends to be higher. You’re going to see that the exponential moving average, because it’s front weighted, because the new data is given much more weight than the old data. The 200-day average is going to be leading, it’s going to be on top of the 200-day simple moving average, the EMA is always going to be on top of the SMA, but does it really matter?
Similarly with the 50-day average, you’re going to see the same. But if you’ve got a stock that’s just kind of chopping around like this but generally trending higher, you’re going to see the exponential moving average of the longer-term moving averages, you’re going to see that on top. On the shorter moving averages you’re going to see it chopping around every which way. So my suggestion is, just use what works for you, switch them around if you want, get comfortable with one verses the other, but what’s really, really, really most important is that you stick with the trend. For example you don’t buy a pullback just because it’s a pullback, because this thing may just be a way station on the way to heaven’s basement here, it may just keep going.
What you want to do is, you watch for the pullback and then look for the bounce, it may be off the exponential average it may be off the 200-day moving average, but it also may be just kind of generally in this area. You look and see there’s really no rhyme or reason here, the stock was just consolidating, so I hope this helps. As it relates to Dow ( NYSE:DOW ) though, it’s not a moving average thing. This was prior resistance; it was broken through right here, now it’s support.
So you want to buy Dow ( NYSE:DOW ), buy Dow Chemical ( NYSE:DOW ), keep a stop right there. It doesn’t matter if it’s 50-day exponential or simple moving average, you’re keeping a stop just below support and that’s how you’re going to make this trade on a stock that has been trending higher, consolidating, breaking out, pulling back in what I call a touch and go pattern and now is starting to move higher. So you’ve got your defined support, you’ve got your stop just below there, now you’re trading.
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