Simple Moving Average or SMA – Concept, Workings, Calculation, Strategies & moreLast Updated Date: Nov 19, 2022
Here is a walk through the concept of Simple Moving Average or SMA Indicator, where we shall discuss its working, calculation, various opted strategies, and more.
One of the core indicators in technical analysis is moving averages. There are a plethora of versions available under moving averages.
One of the best moving averages is a simple moving average, as it is pretty easy to construct. In simple terms, it is the average price over a specific period.
The only reason it is called as moving averages because you construct it on the chart bar by bar. Then it forms a line that moves along the chart as the average price changes.
After learning so much about moving averages, it is quite possible you are curious to know about this one too.
Know about Simple Moving Average or SMA Indicator
Simple moving average takes into account a selected price range, ideally closing prices and the number of periods in the particular range. In simple terms, the indicator is an arithmetic moving average.
You can calculate the average by adding recent prices and then divide the figure by a number of time periods in the calculation of average.
For instance, you can add the closing price of a stock for a time period. Then you can divide the same by a number of periods.
The best part about short term averages is that they can adjust to changes rapidly in the price of the stock.
On the other hand, long term averages tend to react slowly to the changes in the price of the underlying stock.
The different types of moving averages include the exponential moving average (EMA) and the weighted moving average (WMA).
In simple terms, SMA Indicators are all about a stock’s average closing price over a specific time. The only reason they are moving averages is the price of the stock changes frequently.
Hence, they adjust as per the price levels. The main agenda of all the moving averages is to establish a way in which the price of the stock moves.
It is mainly based on historical data.
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How to use Simple Moving Average Indicator?
Often, the majority of traders choose to use them to determine the direction of the trend. The trend seems to be up; then you need to know the simple moving average signal is going up.
The trend goes down when the simple moving average is moving down. For the long term trend, 200 SMA is one of the most common trends.
Typically, traders use 50 SMAs to gauge the intermediate trends. You can use a shorter period of SMAs to evaluate the more temporary moving trends.
Commonly the traders use SMA to smooth price data and technical indicators.
If the duration of the SMA is long, then the result will be smoother. But here, the catch is more lag comes in between the source and the average.
Often traders use the price crossing the Simple moving average indicator to trigger the trading signals.
Traders choose to go long or cover shot when prices cross over SMA. On the other hand, traders decide to go short or exit long when the prices cross below SMA.
Another standard trading signal is stock price crossing the Simple Moving Average. You might want to go long if the SMA crosses the extended period.
When the SMA crosses back below the long term SMA, then commonly traders want to go short.
How to calculate the Simple Moving Average or SMA?
An=the price of an asset during the specific period
n=the number of total periods
For Example – You calculate the simple moving average of stock by considering the closing prices for 15 days. The closing prices can be 20, 22, 24, 25, 23, 26, 28, 26, 29, 27 and 28, 30, 27, 29, 28.
You can easily calculate the ten-day moving average out of the closing prices of 10 days as the data point’s first set.
The next set of data is most likely to drop at the earliest price, so you can add that on the 11th day and then get an average.
In the same way, you can calculate data for 50 days by accumulating enough data for 50 consecutive days.
Well, we can say that a simple moving average indicator is pretty much customizable as you can calculate it on several time periods.
All you need to do is add the closing price of the underlying securities for various time periods.
Lastly, you need to divide this by the total time periods so you can get the average of the stock over a specific time period.
The best part about SMA Indicator is that it keeps volatility away, so you can easily view the trend of price security.
The price of the security is increasing when the SMA Signal moves up. The price of the stock is decreasing when the simple moving average moves down.
It is relatively smooth if the time frame of the moving average is long.
Trading strategies using SMA Indicator
Buying and selling on SMA intersections – Often, technical traders, to time their buy and sell trades use this average.
When the price of the security intersects with the SMA line, then traders perform their analysis.
Smooth moving averages crossover strategy – Another technical element traders use to enter and exit the market is the smooth moving averages crossover strategy.
The SMA lines most likely include two different time frames. Some of the most common averages that long term investors use include 50-day and 200-day SMAs.
On the other hand, short term investors use 10-day and 20-day SMAs.
Drawbacks of Simple Moving Average
Well, it is not yet clear whether it is a time period or data on what more emphasis is given. The majority of the traders believe that new data reflects better on the current trend.
Some traders also believe that giving priority to some dates will lead to bias of the trend. But all we say is SMA lies majority on the past data.
The issue with historical data is the traders get no information about the future.
Conclusion – Simple Moving Average or SMA Indicator
The simple moving average is a technical indicator that helps in assessing if the price will continue the trend or it will reverse with a bull or bear trend.
The only difference between SMA and EMA is that EMA puts a lot of weight on the current prices. The SMA tends to put on equal weight on all data points.
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