Simple Moving Average
The simple moving average (SMA) is a popular technical analysis tool. Used mainly to identify trends, it is one of the most commonly used indicators across all financial markets. The SMA works by smoothing out past price data and is generally seen as a lagging indicator. Trading with the SMA shows the average price of a security over a certain length of time and is plotted as a single line on a candlestick chart. Because it is customisable over different time horizons, the SMA is used by both short-term traders and long-term investors.
Simple Moving Average calculation
The SMA formula is calculated by averaging a number of past data points. Past closing prices are most often used as data points. For example, to calculate a security’s 20-day SMA, the closing prices of the past 20 days would be added up, and then divided by 20.
How to use a simple moving average
There are two main ways to use the simple moving average. The first is trend analysis. At a very basic level, traders and investors use the SMA to assess market sentiment and get an idea of whether the price of a security is trending up or down. The basic rule for trading with the SMA is that a security trading above its SMA is in an uptrend, while a security trading below its SMA is in a downtrend. For example, a security trading above its 20-day SMA is thought to be in a short-term uptrend. In contrast, a security trading below its 20-day SMA is thought to be in a long-term downtrend. By analysing the SMA, the investor or trader can quickly assess market trends and determine whether the security is trending upward or downward. During a trend, the SMA will provide a dynamic level of support or resistance.
