Traders use a variety of moving averages (MAs) in their technical analysis to smooth out price data and identify trends. A simple moving average (SMA) is the most basic type of moving average and the simplest, so it is considered a core technical indicator. What is the SMA indicator? In this FXOpen guide, we explain how to calculate a simple moving average and how to use it in your trading.
What Is an SMA in Trading?
A simple moving average (SMA) is the technical analysis indicator, standing for an average price of an asset over a given period. What is an SMA line? The SMA is plotted on a price chart in the form of a line that moves as soon as new price data appears – for instance; it will change every minute on a 1-minute chart and every 4 hours on a 4-hour chart. The line aims to smooth out the price volatility to make it easier to determine the market direction. The degree of smoothing depends on the MA’s period.
The chart below shows how MA lines smooth out pricing for EURUSD and how short-term averages tend to respond to changes faster than long-term averages, which create a smoother line but are slower to react.
What is the SMA in stocks? The SMA in stocks is the same as simple MAs in forex, commodities, indices, and cryptocurrencies*.
How to Calculate the Simple Moving Average
The SMA is simply an arithmetic moving average that calculates the average of a range of prices, typically closing prices, over a specified time period. The simple moving average formula adds up the closing values and divides them by the total number of periods (n) in the range. As the SMA is based on previous data, it is a lagging indicator. Therefore, it displays pre-established market movements and can’t predict future direction.
The simple moving average equation is customisable, as it can be calculated for different periods. As an example, a 10-day SMA averages the price data for an asset for 10 consecutive days on a rolling basis, adding the closing prices and then dividing the total by 10. The calculation for the next day drops the earliest value and adds the value for day 11 so that there are still 10 data points added up and divided by 10. The calculation is the same for 9, 50, and 200 consecutive periods.
Most trading platforms, such as TickTrader, will perform the calculation automatically, but it is useful to know how to calculate the SMA so that you can adjust it as needed to respond to changes in the market environment and develop different trading strategies.
How to Trade with the Simple Moving Average
What is the simple moving average used for in trading? The indicator provides a broader view of the market than the price alone. You can use SMA technical analysis in several ways to inform your trading strategy and identify when to enter and exit positions.
Identify Price Trends
The simplest way to use the indicator is to identify whether the asset is trending higher, lower, or has become range bound. Use it to compare short, medium- and long-term trends over time and take a view on whether there is potential for an established trend to change direction.
The SMA is added to the chart, meaning traders look for chart and line interactions. If the line on a chart is pointing higher and the price is above it, the asset is in an upward trend. If the line is pointing lower and the price is below it, the asset is in a downward trend.
Trade SMA Intersections
You can look for prices crossing their simple MA lines as buy and sell signals. When a price crosses above the line, you could open a long position, and when it crosses below, you could go short as the SMA serves as a support and resistance level. Therefore, when the price falls below it, it’s the same as if it had broken below the support level.
The chart above shows a simple moving average example. When the asset moves above the line, it often trends higher for some time, providing a buy signal (1). When it falls below the line, prices tend to trend lower for some time, so the intersection provides a sell signal (2).
However, you should exercise caution when trying to time entries and exits based on intersections due to the lag in the underlying data. Traders use it in conjunction with other technical indicators to develop a clearer picture of the market.
Trade SMA Crossovers
Comparing MAs of different periods often provides a stronger signal of the market’s direction. You can use SMA line crosses as a signal of when to enter and exit trades. If a short-term moving average is above a longer-term MA, it confirms an upward trend, and if the long-term indicator is above the short-term line, it points to a downward trend. Although there is a general rule that traders should combine 9-, 14-, and 21-period MAs for low timeframes and 50-, 100-, and 200-period MAs for high timeframes, you can find numerous strategies where 9-period MA is used with 60-period MA.
There are two popular trading patterns based on simple MA crossovers. When a shorter MA crosses below a longer one, it is known as a death cross (1), which provides a bearish signal indicating the potential for further declines. When the short-term MA breaks above the long-term indicator, it is known as a golden cross (2), which indicates that the asset has the potential to make further gains – especially when it is supported by high trading volumes.
What Is the Difference Between an SMA, an EMA, and a WMA?
There are several other types of MAs, including the exponential moving average (EMA) and weighted moving average (WMA). The main difference between a simple MA, weighted MA, and exponential MA is the way they are calculated.
The simple MA is used as the basis of the weighted MA, which gives more weight to recent price data rather than giving equal weight to each data point. The exponential MA is also weighted, but the difference in the weighting of each data point is exponential.
The SMA, EMA, and WMA are interpreted in the same way and smooth out fluctuations. But EMAs are viewed as being more responsive to trends than SMAs and WMAs. While the EMA is more responsive to trend changes, the smoother simple MA is effective in finding simple support and resistance areas.
Limitations of the Simple Moving Average
While the simple MA is a useful trading indicator, you should be aware of its limitations. The indicator is susceptible to price spikes and sometimes gives false signals.
By giving equal weight to all prices, the simple MA doesn’t distinguish between those with higher volatility and lower volatility, while such data can provide valuable knowledge about the market trend. This makes it slower to respond to trend reversals, so it tends to be used by traders for trend confirmation, not for predictions.
Shorter-term averages have a higher chance of providing a false signal as short-term trends change quickly.
You need to be able to interpret the interaction between the price and the average because a moving average alone does not tell you what is considered a significant movement.
The simple MA is a straightforward technical analysis indicator that can help you form a trading strategy. Traders use it to look for changes in the direction of trends and crossovers that provide buy and sell signals. You can open an FXOpen account to practise using the indicator on live price charts.
*At FXOpen UK and FXOpen AU, Cryptocurrency CFDs are only available for trading by those clients categorised as Professional clients under FCA Rules and Professional clients under ASIC Rules, respectively. They are not available for trading by Retail clients.