|Simple moving average indicator|
Simple moving average indicator or SMA, is a technical indicator which averages the closing prices in a specified period. Simple moving average is used in technical analysis of financial markets. Using this indicator, traders can anticipate the future movements of the market based on its recent activities.
Simple moving average concept
For calculating the simple moving average, first, all prices are summed up in a specified time period. After that, the result is divided by the number of the candlesticks in that period. For example, to determine the simple moving average in a period, you just need to sum up the closing prices of all candles in a period and divide the result by the number of the candles. Short-term averages tend to reflect the market movements with less latency. On the other hand, long-term averages reflect the changes more slowly. There are also other types of moving averages. Other types of moving averages include Exponential Moving Average (EMA) and Weighted Moving Average (WMA).
Calculating SMA indicator
The 10-day simple moving average, averages the closing prices of the first 10 days as the first data point. Then, for the next data point, the 11th day is added and the averaging process is carried out once more. The existing process repeats for all the next data points. Therefore, to calculate the 50-day simple moving average, the closing prices of the recent 50 days is placed in the existing algorithm.
Simple moving average can be easily adjusted, because the time period in which the moving average is calculated can be changed. After confirming the desired time period, this indicator sums up the closing prices of candles and divides them up by the number of candlesticks according to the specified period. At last, simple moving average is calculated for the chosen time period.
Simple moving average, smooths the existing volatility of the market and makes it easier to monitor the trend of the market. If the simple moving average of a certain market moves in the upward direction, it means that this security is in an uptrend. Conversely, if the simple moving average moves in the downward direction, it means that this security is currently in a downtrend. The graph of simple moving average is smoother when a longer timeframe is chosen. On the other hand, when a shorter timeframe is chosen, the simple moving average is more volatile, but the data is closer to the reality of the market.
Advantages of simple moving average "Technical importance"
Moving averages are important tools in technical analysis. These indicators are used to determine the current trend of the market and its potential to change. The most simple way to use simple moving average in technical analysis, is to determine trends with it.
Another more complex use of simple moving average is to compare several moving averages in different timeframes in order to generate trading signals. If the short-term moving average crosses above the long-term moving average, it is expected that an uptrend starts in the market very soon. On the other hand, if the long-term moving average crosses above the short-term moving average, the market is expected to fall.
Popular trading patterns
Two popular trading patterns which are used very often include “death cross” and “golden cross”. The death cross occurs when the 50-day moving average crosses the 200-day moving average in the downward direction. This pattern shows that the market is going to fall very soon. The golden cross pattern takes place when a short-term moving average crosses above a long-term moving average. In this case, if the trading volume is high enough, it could be a buying opportunity.
Differences and similarities between SMA and EMA
The most important difference between an exponential moving average and a simple moving average is their sensitivity to variation of data. Generally, when calculating exponential moving average, recent data have more weight, on the other hand, in simple moving average, all data have the same weight.
These two averages are similar, because the way they are calculated is very similar. These indicators are utilized by traders to smooth out the unwanted fluctuations during a specified time period. Since the exponential moving average gives more weight to recent prices, therefore it’s more reliant on time and is preferred to simple moving average by most traders.
Simple moving average limitations
There are no determination regarding the weight of prices throughout the time period. Most traders believe that recent data are better at reflecting the current state of the market. Meanwhile, other traders believe that preferring one set of data to another causes unwanted complexities. Therefore, simple moving average is a kind of moving average which treats all data points equally, whether it’s the 10th data point or it’s the 200th.
Therefore, simple moving average is generally reliant on previous market data. Most people (including economists) believe that markets act in an efficient way. This means that the current market data reflects the current situation of the market. If markets are considered to be efficient, previous market data can not offer any useful information in order to predict the next movement.
Simple moving average in technical analysis
Traders try to predict the long-term trend of a market, using the simple moving average. One of the most important advantages of this moving average is that it smooths out the volatility of the market and eliminates short-term distortions. This feature allows traders to compare the short-term and long-term trend of the market. For example, if the 200-day moving average crosses below the 50-day moving average, it shows a death cross which is a bearish signal. On the other hand, if the golden cross pattern shows up, an uptrend is expected to happen.
A forex broker must provide its clients with such features and tools to ensure that they are analyzing the market carefully before starting to trade. Aron Groups Broker facilitates trading by providing its clients with MetaTrader 5 as a trading platform. In MetaTrader 5, traders can access numerous technical features including simple moving averages, exponential moving averages, momentum indicators, trendlines, etc. You can also open a demo account in Aron Groups Broker to test your strategy before starting to trade in the real market with your real assets.
Written by: Mohsen Mohseni (Aron Groups).