Simple Moving Average (SMA)
Tue, Apr 15A Simple Moving Average (SMA) is a technical indicator that represents the average price of an asset over a designated time frame. It is computed by summing a series of prices and then dividing that total by the number of data points.
For instance, if the latest three prices are 1, 2, and 3, the average would be calculated by adding these prices together (1+2+3) and dividing by the number of periods. The total of the prices is 6, and since there are 3 reporting periods, 6 divided by 3 equals 2.
The term “moving average” refers to how the SMA is displayed on a chart, creating a line that shifts as the average price changes with each new data point. Each time a new price is recorded, the average adjusts to reflect only the most recent set of reporting periods.
Utilizing a Simple Moving Average aids in minimizing the noise from fluctuating prices, allowing for a clearer view of the overall trend direction.
SMAs are employed to smooth out price data. A longer SMA period results in a smoother output, but it also introduces more lag between the SMA and the actual price.
SMAs are useful for identifying trend direction:
- If the SMA is trending upwards, the overall trend is considered upward.
- If the SMA is trending downwards, the overall trend is considered downward.
A 200-period SMA is typically used to assess long-term trends, while a 50-period SMA is used for intermediate trends. Shorter-term trends can be evaluated using 5, 10, or 20-period SMAs.
When the price crosses above or below an SMA:
- If the price crosses above the SMA, it suggests an upward trend, indicating that the price is increasing at a faster rate than the moving average, which is seen as bullish.
- If the price crosses below the SMA, it indicates a downward trend, suggesting that the price is decreasing at a faster rate than the moving average, which is viewed as bearish.
When one SMA crosses above or below another SMA:
To analyze this, place two SMAs on the same price chart. Typically, a “faster” moving average, which consists of fewer data points, is paired with a “slower” moving average. When the faster moving average crosses above the slower moving average, it is interpreted as a buy signal. Conversely, when the faster moving average crosses below the slower moving average, it is seen as a sell signal.
Unlike the Weighted Moving Average (WMA) or Exponential Moving Average (EMA), the SMA is simply the mean of the price values over a specified period. The formula is as follows:
SMA = (A1 + A2 + ……….An) / n
Where:
- A = average in period n
- n = number of periods
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