What Is a Simple Moving Average (SMA)?
A simple moving average (SMA) is a statistical measure that computes the average price of a financial asset, typically based on its closing prices, over a defined time frame. Key Insights The simple moving average provides an average price over a designated period.
As a technical analysis tool, the simple moving average assists in assessing whether the price of an asset is likely to maintain its current trend or reverse from a bullish or bearish trajectory. The simple moving average can be refined into an exponential moving average (EMA), which places greater emphasis on more recent price movements.
Understanding Simple Moving Average (SMA)
A simple moving average (SMA) is a statistical measure that is computed by summing the most recent prices and subsequently dividing this sum by the number of periods considered in the average. For instance, one might aggregate the closing prices of a financial instrument over a specified number of periods and then divide this cumulative value by the same number of periods.
Short-term moving averages tend to adjust rapidly to fluctuations in the price of the underlying asset, whereas long-term moving averages exhibit a more gradual response. Additionally, there exist other forms of moving averages, such as the exponential moving average (EMA) and the weighted moving average (WMA).
The formula for SMA is:
SMA=A1+A2+…+Annwhere:An=the price of an asset at period nn=the number of total periodsSMA=nA1+A2+…+Anwhere:An=the price of an asset at period nn=the number of total periods
For example, this is how you would calculate the simple moving average of a security with the following closing prices over a 15-day period.
Week One (5 days): 20, 22, 24, 25, 23
Week Two (5 days): 26, 28, 26, 29, 27
Week Three (5 days): 28, 30, 27, 29, 28
20 + 22 + 24 + 25 + 23 + 26 + 28 + 26 + 29 + 27 + 28 + 30 + 27 + 29 + 28 = 392
392 / 15 = 26.13
The 15-day simple moving average for this security would be $26.13.
A 10-day moving average would average out the closing prices only the most recent 10 days rather than using all 15. Each day when the stock market closes, there is a new most recent closing price. This replaces the oldest one being used, and a new, up-to-date moving average is calculated. A 50-day moving average would use 50 days worth of data to compute the average price on a rolling basis.
A simple moving average is customizable because it can be calculated for different numbers of time periods. This is done by adding the closing price of the security for a number of time periods and then dividing this total by the number of time periods, which gives the average price of the security over the time period.
A simple moving average serves to mitigate fluctuations, thereby facilitating a clearer observation of a security’s price trend. An upward trajectory of the simple moving average indicates an increase in the security’s price, while a downward trajectory signifies a decrease.
The duration of the moving average period directly influences its smoothness; longer time frames yield a more stable average. Conversely, a shorter-term moving average exhibits greater volatility, yet it remains more closely aligned with the original data.
One of the most popular simple moving averages is the 200-day SMA. However, there is a danger to following the crowd. As The Wall Street Journal explains, since thousands of traders base their strategies around the 200-day SMA, there is a chance that these predictions could become self-fulfilling and limit price movements.
Special Considerations
Analytical Importance
Moving averages serve as a crucial analytical instrument for discerning current price trends and assessing the likelihood of a shift in an existing trend. The most straightforward application of a simple moving average (SMA) in technical analysis involves its use to swiftly ascertain whether an asset is experiencing an upward or downward trend.
A more intricate analytical approach involves the comparison of two simple moving averages, each representing different time frames. When a shorter-term simple moving average is positioned above a longer-term average, it suggests the anticipation of an upward trend. Conversely, if the longer-term average is situated above the shorter-term average, a downward trend may be anticipated.
Popular Trading Patterns
Two popular trading patterns that use simple moving averages include the death cross and a golden cross. A death cross occurs when the 50-day SMA crosses below the 200-day SMA. This is considered a bearish signal, indicating that further losses are in store. The golden cross occurs when a short-term SMA breaks above a long-term SMA. Reinforced by high trading volumes, this can signal further gains are in store.
Simple Moving Average vs. Exponential Moving Average
In contrasting an exponential moving average (EMA) and a simple moving average the major difference is the sensitivity each one shows to changes in the data used in its calculation. More specifically, the EMA gives a higher weighting to recent prices, while the SMA assigns an equal weighting to all values.
The two averages are similar because they are interpreted in the same manner and are both commonly used by technical traders to smooth out price fluctuations. Since EMAs place a higher weighting on recent data than on older data, they are more reactive to the latest price changes than SMAs are, which makes the results from EMAs more timely and explains why the EMA is the preferred average among many traders.
Limitations of Simple Moving Average
The question of whether greater weight should be assigned to the most recent days within a given time frame, as opposed to more distant data points, remains ambiguous. A segment of traders posits that recent data is more indicative of the current trend in a security’s movement.
Conversely, another group contends that favoring specific dates over others may introduce bias into the trend analysis. Consequently, the Simple Moving Average (SMA) may disproportionately depend on older data, as it assigns equal significance to the impacts of the 10th or 200th day as it does to the first or second day.
In addition, the SMA is entirely reliant on historical data. A number of individuals, including some economists, advocate for the notion of market efficiency, encapsulated in the efficient market hypothesis. This theory asserts that current market prices incorporate all available information. If markets operate efficiently, then historical data would provide little insight into the future trajectory of asset prices. While some economic and financial theorists endorse this hypothesis, there exists a substantial contingent that challenges it.
How Are Simple Moving Averages Used in Technical Analysis?
Traders use simple moving averages (SMAs) to chart the long-term trajectory of a stock or other security, while ignoring the noise of day-to-day price movements. This allows traders to compare medium- and long-term trends over a larger time horizon. For example, if the 50-day SMA of a security falls below its 200-day SMA, this is usually interpreted as a bearish death cross pattern and a signal of further declines. The opposite pattern, the golden cross, indicates potential for a market rally.
How Do You Calculate a Simple Moving Average?
To calculate a simple moving average, the sum of the prices within a time period is divided by the number of prices. For instance, consider shares of Tesla closed at $10, $11, $12, $11, $14 over a five day period. The simple moving average of Tesla’s shares for this 5-day period would equal $10 + $11 + $12 + $11 + $14 divided by 5, which equals $11.6.
What Is the Difference Between a Simple Moving Average and an Exponential Moving Average?
While a simple moving average gives equal weight to each of the values within a time period, an exponential moving average places greater weight on recent prices. Exponential moving averages are typically seen as a more timely indicator of a price trend, and because of this, many traders prefer using this over a simple moving average. Common short-term exponential moving averages include the 12-day and 26-day. The 50-day and 200-day exponential moving averages are used to indicate long-term trends.
Final Thoughts
Getting started with free premium crypto signals is one of the smartest moves you can make as a new or even experienced trader. It’s a low-risk way to test profitable strategies, sharpen your skills, and build confidence in crypto trading. Ready to elevate your trading experience?
Get Started with Free Premium Signals Today!
🔗 Join our Free Telegram Channel
