The ordinary moving median (SMA) is a well-known mechanism of technological consideration. Used mainly to reveal trends, it is considered to be one of the more frequently used indicators in absolutely all economic bazaars. SMA functions due to the result of smoothing of previous price data and also as a rule is considered as a lagging pointer.
Trading activity together with the use of SMA demonstrates the mediocre value of a significant document because of a specific period and is also based on a variant of one direction in the candlestick chart. Since the SMA is set up for a variety of short-term interests, it is used by short-term traders as well as long-term investors. For example, a short-term trader can use the 20-day elementary moving average to reveal short-term price trends. In contrast to this, a long-term investor can use the 200-day SMA to establish long-term rate changes. It can be used in absolutely all economic bazaars, such as promotions, monetary units, indices, and exchange-traded funds (ETFs).
What is the simple moving average?
The regular moving intermediate is considered a lagging indicator, as it is based on the previous price information. The more transient the SMA interval, the more lagging. Even though the SMA is considered a necessary device of technological consideration, it is better to use it in general together with other common indicators, such as the direction of rate changes and size study.
In the bulk of trader scenarios, the SMA is based on the price chart together with the exponential moving typical (EMA). They have the same features and differences, however, as well as most of the industrial indicators, they function more correctly in general together to establish price directions and impulse in trading.
How to calculate SMA
The simple moving average is calculated quite simply. Most trading platforms offer tools for the automatic calculation of SMA. This means that traders will rarely have to manually calculate the SMA for their trades, since modern charting programs perform all calculations instantly. However, the formula below is good for the general familiarization of the trader.
SMA Indicator Formula
- The SMA formula is calculated by averaging several past data points. Most often, past closing prices are used as data points.
- For example, to calculate the 20-day SMA of security, you need to add up the closing prices for the last 20 days, and then divide by 20.
- Similarly, to calculate the 200-day SMA of security, the closing prices for the last 200 days are summed up and divided by 200.
How to use a simple moving average?
There are two main ways to use a simple moving average. The first is trend analysis. At the most basic level, traders and investors use SMA to assess market sentiment and get an idea of whether the price of a particular security is moving up or down.
The basic rule of trading using SMA is that a security trading above its SMA is in an uptrend, and a security trading below its SMA is in a downtrend. For example, a security trading above its 20-day SMA is considered to be in a short-term uptrend. Conversely, a security trading below its 20-day SMA is considered to be in a long-term downtrend. By analyzing the SMA, an investor or trader can quickly assess market trends and determine whether security has an uptrend or a downtrend.
Simple moving averages can be useful in identifying trend changes. They can also be used to determine support and resistance levels. Often during a trend, the SMA represents a dynamic support or resistance level. For example, a security that is in a long-term uptrend may constantly retreat a little, but find support at the level of the 200-day SMA. It can also be useful for detecting a trend change. This method can be used in many markets, including currency, indices, and stock markets.
Difference between simple and exponential moving average
A simple moving average is the simplest type of moving average. It is calculated by adding up past data points and then dividing by the total number of data points. Although SMA is a very popular technical indicator, it has one major drawback. Some traders and investors believe that it is imperfect because each data point has the same weight. They argue that the current data is more important than the previous ones, and therefore should have more weight. As a result, some traders and investors prefer to use another form of moving average, known as exponential moving Average (EMA). Compared to the SMA, the exponential moving average gives more weight to the most recent prices. This is the key difference between SMA and EMA. The EMA is more responsive to the latest data than the SMA since the latest data has a greater impact on the calculation. Calculating the EMA is more complicated than the SMA. However, like SMA, most of the available charting programs draw the EMA line at the click of a button, including our Next Generation trading platform.
Simple moving average and technical analysis
Technical analysis is mainly used by short-term traders in strategies such as day trading. This type of analysis uses past stock price models to predict future price movements. Fundamental analysis, on the contrary, is preferred by long-term investors. This type of analysis focuses on economic indicators, such as revenue, profit, and growth of the company, to identify potential investments.
One of the advantages of a simple moving average is that this tool can be used for both technical and fundamental analysis. Although the two styles are very different from each other, a simple moving average can be used to complement both. For example, a short-term trader trading using technical analysis may be interested in finding out whether security tends to rise or fall over 10 days. Such a trader can analyze the 10-day SMA to determine the trend.
On the contrary, a long-term investor who usually uses fundamental analysis may be more interested in buying an ascending security after a pullback to the 200-day SMA. Such an investor can use SMA to determine an attractive entry point.
Simple moving average strategy
There are many different trend strategies based on the use of a simple moving average. The two most popular signals that traders are looking for are bullish and bearish intersections.
A bullish intersection occurs when the price of a security returns above the SMA after being below it. This action signals that the downtrend or correction has ended and a possible uptrend is beginning. A bullish intersection can be used as a signal to enter a long trade. In trending markets, this signal can be quite reliable. However, in turbulent or sideways markets, this indicator may be less reliable when assessing market fluctuations. Bullish intersections are less important when the long-term trend is down.
A bearish intersection occurs when the price of a security falls below the SMA after it has traded above it. This action signals that the uptrend has ended, and now the trend may be a downtrend. A bearish intersection can be used as a signal to exit a long position or, conversely, to enter a short position. In unstable or sideways markets, the “bearish” intersection is less significant.
Another popular strategy using SMA is crossing the moving average. This happens when the short-term SMA crosses the long-term SMA. The intersection of moving averages is often referred to as the “golden cross” or “death cross”.
A golden cross occurs when the short-term SMA of a security crosses over its long-term SMA. For example, the classic option is to cross the 50-day SMA over the 200-day SMA. This is a bullish signal that indicates the possibility of further growth in the price of the security. The golden intersection can be used as a trading signal to enter a long trade.
The reverse side of the “golden cross” is a “bearish” indicator, known as the “cross of death”. The death cross is determined when the short-term SMA of a security crosses below its long-term SMA. For example, the 50-day SMA may cross and fall below the 200-day SMA. This is a “bearish” signal and indicates that the price of the paper may continue to fall. The Death Cross can be used as an exit strategy.
Set up the simple moving average algorithm
Our Next Generation trading platform has a wide range of technical indicators that can be used in any financial market for both short-term and long-term trading strategies. For the convenience of trading, a simple moving average indicator is automatically calculated, as well as an exponential moving average. They work best in combination with other popular trend indicators such as Bollinger Bands, Relative Strength Index (RSI), stochastic oscillator and ADX indicator.
You can read more about the capabilities of our charts here to take advantage of our construction tools, technical indicators, and price forecasting tools. We offer various types of graph displays for visual representation of data.
SMA for MT4
Our international MetaTrader 4 platform also comes with a built-in Simpe moving average indicator, for users who are already familiar with this trading platform.
Summary: SMA Trading
The Simple Moving Average is a popular tool that can be useful for both short-term traders and long-term investors. The SMA smooths price data by averaging the price of a security over a certain period. It is drawn as a single line on the chart and helps in identifying trends. The advantage of an SMA is that it allows a trader or investor to quickly determine whether a security is trending up or down.