A technical analysis indicator called a Simple Moving Average (SMA) shows an asset’s average price over a predetermined period. It reduces the noise created by volatility and helps determine the trend’s direction.
Assets’ price behavior can be chaotic at times, with very high openings, lows, gaps, and other dramatic shifts. When we try to average the price behavior across a set number of periods, we decrease the visual noise on the chart and gain a clearer understanding.
What is SMA?
A stock’s average closing price over a certain period is referred to as its Simple Moving Average (SMA). Since the stock price fluctuates often, the moving average also fluctuates. This is why the average is referred to as “moving.” SMA is often the most straightforward moving average to create and is one of the main indicators in technical analysis.
All moving averages aim to identify the trending direction of an asset’s price based on previous prices. SMA is a lag indicator since it is created using previous closing prices. It implies that it doesn’t predict future pricing; it only shows a prior trend.
SMA and EMA, or the exponential moving average, are frequently contrasted. The EMA gives more weight to current prices than the SMA, which gives equal weight to all data points. The SMA line is often smoother as a result.
How Does SMA Work?
Trend direction is frequently determined using SMAs. If the SMA is increasing, the trend is upward. The trend is downward if the SMA is decreasing. A popular substitute for the long-term trend is a 200-bar SMA. Usually, the intermediate trend is evaluated using 50-bar SMAs. Shorter period SMAs can be used to identify shorter duration trends.
Technical indicators and price data are frequently smoothed using SMAs. The smoother the outcome, but the greater the latency between the SMA and the source, the longer the SMA’s duration.
Price crossing trading signals are frequently generated using SMA. You might want to go long or cover short when prices cross above the SMA. You might want to go shorter or exit long when they cross below.
Another typical trading indication is the SMA crossing. You might want to go long when a short-term SMA crosses above a long-term SMA. You might wish to sell when the short-term SMA crosses back below the long-term one.
Simple Moving Average VS. Exponential Moving Average
An exponential moving average lends more weight to current prices than a simple moving average, which gives equal weight to all values over a specific time period.
Many traders prefer using exponential moving averages over simple ones because they are considered to be a more timely predictor of a price trend. The 12-day and 26-day are typical short-term exponential moving averages. Long-term trends are shown by the 50-day and 200-day exponential moving averages.
The degree to which each moving average is sensitive to changes in the data used in its calculation is the main difference between an exponential moving average and a simple one. More specifically, the SMA gives all values the same weight, but the EMA gives recent prices a larger weighting.
The two averages are similar because technical traders often use them to smooth out price volatility and because they both have the same meaning. EMAs are the favorite average among many traders. They react more quickly to the most recent price movements than SMAs do because they give recent data a larger weighting than older data.
How is SMA Calculated?
You can select the number of periods that you want to average with the Simple Moving Average because it is an entirely customizable indicator.
Because of this, you might probably hear expressions like 200 SMA, 50 SMA, and 20 SMA. This indicates that a calculation of the asset’s average closing prices over the previous 200,50, or 20 days was plotted at each point of the smooth line you see as the SMA.
Closing prices are identified as CP1, CP2, or CP3. The chosen number of periods is three.
The formula above is used to determine a 3 SMA in this example. Only three closing prices are considered and divided into three periods.
Takeaways
- A simple Moving Average (SMA) shows an asset’s average price over a predetermined period.
- A stock’s average closing price over a certain period is referred to as its Simple Moving Average (SMA).
- Trend direction is frequently determined using SMAs.
- If the SMA is increasing, the trend is upward. The trend is downward if the SMA is decreasing.
- You can select the number of periods that you want to average with the Simple Moving Average.
