What is SMA(Simple Moving Average) Indicator?
Contents:
What is SMA indicator?
Moving average is one of the core indicators of technical analysis, and there are various versions. Simple Moving Average (SMA) is the simplest and easiest moving average to construct. It calculates the average of the selected price range (usually the closing price) based on the number of periods in that range, by adding the most recent set of data points and dividing the total by the number of time periods. Moving Average is called a “moving” because it is plotted on the chart one by one, forming a line that moves along the chart as the average changes.
Simple Moving Average (SMA) is a lagging indicator because it is based on past price data for a specific period and can be used to help identify buy and sell signals for an asset, as well as Support and Resistance.
Calculation
The Simple Moving Average is an unweighted moving average. This means that each day in the dataset has equal importance and is given equal weight. At the end of each new day, the oldest data points are removed and the newest data points are added at the beginning.
- An example of a 3 period SMA:
Sum of Period Values / Number of Periods: 3
Closing Prices to be used: 5, 6, 7, 8, 9
First Day of 3 Period SMA: (5 + 6 + 7) / 3 = 6
Second Day of 3 Period SMA: (6 + 7 + 8) / 3 = 7
Third Day of 3 Period SMA: (7 + 8 + 9) /3 = 8
Basically, SMA with a short time frame tends to stay close to the current price level, reduces lag, and will move as soon as the price moves. The longer time frame has more cumbersome data, its movement will lag behind the market movement more obviously, and the more it can reflect the long-term overall price trend. Typically, anything under 20 days is considered short-term, anything between 20 and 60 days is considered medium-term, and of course, anything over 60 days is considered long-term. Investors can choose different moving averages according to the time period that their own trading strategies focus on.
Applied rules
Using SMA to confirm price trends is indeed one of the most basic and effective ways to use this indicator.
1. The general rules of thumb are as follows:
- A Long-Term SMA that is clearly on the upswing is confirmation of a Bullish Trend.
- A Long-Term SMA that is clearly on the downswing is confirmation of a Bearish Trend.
2. Support and Resistance
- Another fairly basic use for SMA is identifying areas of support and resistance. Generally speaking, SMA can provide support in an uptrend, and also they can provide resistance in a downtrend. While this can work for shorter term periods (20 days or less), the support and resistance provided by SMA can become even more readily apparent in longer term situations.
3. Golden Cross and Dead Cross
Crossovers require the use of two SMA of different durations on the same chart. A signal or potential trading opportunity occurs when a shorter-term SMA crosses above or below a longer-term SMA.
- Bullish Crossover – occurs when the short-term SMA is above the long-term SMA. Also known as a Golden Cross.
- Bearish Crossover – occurs when the short-term SMA is below the long-term SMA. Also known as a Dead Cross.
4. Price Crossovers
If you take a setup with two SMAs and add a third element of price, another type of setup occurs called a price crossover. Let’s use the 50-day SMA and 200-day SMA as an example.
- Bullish Price Crossover – Price crosses above the 50 SMA while the 50 SMA is above the 200 SMA. The 200 SMA is confirming the trend. Price and short term SMA are generating signals in the same direction as the trend.
- Bearish Price Crossover – Price crosses below the 50 SMA while the 50 SMA is below the 200 SMA. The 200 SMA is confirming the trend. Price and short term SMA are generating signals in the same direction as the trend.
Summary:
SMA (Simple Moving Average) is an important reference index to measure the cost of the main force, which is used to observe the price fluctuation trend and play the role of testing support and resistance. When judging as a trend, the longer the period, the more effective. On the other hand, it should be noted that when the SMA forms a long position, the short-term SMA is used as the basis for holding positions.
Traders must recognize the inherent flaws in these signals. This is a system made up of signals from lagging indicators. React only to what has happened, not to predict. A system like this certainly works best in very strong trends. In a strong trend, this system or a similar system can actually be quite valuable.
Care should be taken when using SMA (as with any indicator). They are trend spotters, and they do what many other indicators that have stood the test of time provide an extra level of confidence to a trading strategy or system. When used with more aggressive indicators, you can at least be sure that you are looking in the right direction for your trade in terms of the long-term trend.
Reference: