Simple Moving Average: SMA in Trading

what is the simple moving average

The most popular moving averages for longer-term investors are the 50-day and 200-day SMAs. For shorter-term investors, the 10-day and 20-day SMAs are often used as well. A moving average helps to smooth price action and filter out noise in the data. It is used to identify trend direction, define potential support and resistance levels, and serves as a building block for many other technical indicators. Simple moving averages, on the other hand, represent a true average of prices for the entire time period. As such, simple moving averages may be better suited to identify support or resistance levels.

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These moving averages are widely recognized and are considered to be highly reliable indicators of market trends. In this article, we’ll take a closer look at the simple moving average and how to use it to analyze stock charts. We’ll also discuss the SMA as a trading strategy to help you decide whether it’s the right fit for your trading style.

What Is the Simple Moving Average? (And How Do Traders Interpret It)

While the two styles are very different, the simple moving average can be used to complement both. For example, a short-term trader that trades using technical analysis may be interested in finding out whether a security is trending up or down over a 10-day period. In most trading scenarios, the SMA is plotted on a price chart along with the exponential moving average (EMA). They share similarities and differences but, like most technical indicators, they work best together to define price trends and momentum in trading. A simple moving average is the average stock price over a past period.

what is the simple moving average

They argue that current data is more important than previous data and should therefore have a higher weight. As a result, some traders and investors prefer to use another form of moving average, known as the exponential moving average (EMA). A simple moving average is formed by computing the average price of a security over a specific number of periods. Most moving averages are based on closing prices; for example, a 5-day simple moving average is the five-day sum of closing prices divided by five. Old data is dropped as new data becomes available, causing the average to move along the time scale. The example below shows a 5-day moving average evolving over three days.

Moving Average explained

SMA assigns equal weight to all price points, while EMA places more weight on recent data, making it more responsive to recent price changes. Conversely, when the price falls below its SMA, market technicians consider this to be bearish and a sign of weakness. SMA computes the average prices and is called the arithmetic mean in statistical speak.

Traders can compare a pair of simple moving averages, each covering different time frames. This method is called a moving average crossover and involves either buying or selling when a shorter MA crosses a longer MA. For instance, the golden cross, signaling a long position, occurs when the 50-day SMA crosses above a 200-day SMA.

Investor Biases

Moving averages are generally represented by a line on a stock chart. If the line is moving up and the stock price is above it, the stock is considered to be trending up, and vice versa for a declining line. In addition to analyzing individual moving average lines on the ribbon, chartists can glean information from the ribbon itself. If the ribbon is expanding (the lines are moving further apart over time), this indicates the trend is coming to an end. If the ribbon is contracting (the lines are moving closer together or even crossing), this can indicate the start of a new trend. With only 30 data points incorporated in the EMA calculations, the 10-day EMA values in the spreadsheet are not very accurate.

  • It is calculated by adding up past data points and then dividing by the total number of data points.
  • To calculate the moving average using data other than the Close, use the Calculated From field; this can be set to use the Open, High, Low, Volume, or other indicators that are on the chart.
  • The Charles Schwab Corporation provides a full range of brokerage, banking and financial advisory services through its operating subsidiaries.
  • When the underlying price is above the EMA line, it may be considered an upward trend.

The moving average crossover strategy is based on the principle that when two moving averages of different periods cross each other, it indicates a potential change in the market trend. As its original use suggests, moving averages are widely used to identify price trends. When the price moves above the moving average, it is considered to signal a potential uptrend, while a price movement below the moving average may indicate a possible downtrend. Additionally, the slope of the moving average can provide information about the momentum of the trend. Although these data points are accurate, they might not represent the big picture to an investor who is trying to get an idea of how that stock reacts over a period of time.

Trading Platforms

When adding a moving average to your chart, the first choice to make is whether to use an exponential or a simple moving average. Even though there are clear differences between simple moving averages and exponential moving averages, one is not necessarily better than the other. Choosing the right type of moving average depends on your trading objectives. The major difference between an exponential moving average (EMA) and a simple moving average is the sensitivity each one shows to changes in the data used in its calculation. More specifically, the EMA gives a higher weighting to recent prices, while the SMA assigns an equal weighting to all values. A simple moving average is customizable because it can be calculated for different numbers of time periods.

what is the simple moving average

Exponential moving averages have less lag and are therefore more sensitive to recent prices – and recent price changes. A 10-day moving average would average out the closing prices for the first 10 days as the first data point. The next data point would drop the earliest price, add the price on day 11, then take the average, and so on. Likewise, a 50-day moving average would accumulate enough data to average 50 consecutive days of data on a rolling basis. Traders sometimes utilize moving average ribbons, which plot a series of moving averages (both SMAs and EMAs can be used) onto a price chart to create a ribbon-like indicator.

This popular indicator smoothes out price data points and can help you better identify market trends. The SMA can even provide objective signals that can assist you in selecting market entry and exit points as a trader or investor. Benzinga takes a more detailed look at this commonly used indicator below, including explaining how to calculate SMAs and what they can tell you. Traders use simple moving averages (SMAs) to chart the long-term trajectory of a stock or other security, while ignoring the noise of day-to-day price movements. This allows traders to compare medium- and long-term trends over a larger time horizon.

what is the simple moving average

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