SMA - Simple Moving Average
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About
The Simple Moving Average (SMA) is a technical indicator that calculates the average price over a specific number of periods, and it moves along as new data is added, making it a “moving average”.
Calculating
Formula
SMA = (Sum of price data for the last N periods) / N
For example, a 5-period SMA would sum up the last 5 closing prices and divide it by 5 to find the average. It is called a ‘moving’ average because as new prices become available, the oldest prices are dropped and the average recalculates.
| Minute | Open | High | Low | Close | SMA |
|---|---|---|---|---|---|
| 1 | $10.0 | $11.0 | $9.5 | $10.0 | - |
| 2 | $10.1 | $12.1 | $10.0 | $12.0 | - |
| 3 | $12.2 | $15.2 | $12.0 | $15.0 | - |
| 4 | $15.1 | $15.1 | $13.9 | $14.0 | - |
| 5 | $14.1 | $16.1 | $14.0 | $16.0 | $13.4 |
Using our given market data and specifically the closing prices, here’s how the 5-minute SMA would be calculated after Minute 5:
- Minute 1-5 close prices:
$10.0, $12.0, $15.0, $14.0, $16.0 - SMA =
(10.0 + 12.0 + 15.0 + 14.0 + 16.0) / 5 = $13.4
The 5-minute SMA after the 5th minute would be $13.4.
Pros and Cons
Pros:
- The SMA is simple and easy to calculate and understand.
- It smooths out price fluctuations and helps to filter out the “noise” of the market.
- It’s useful for identifying trend directions over the specified period.
Cons:
- The SMA is a lagging indicator, meaning it’s based on past prices and tends to be slow to respond to recent price changes.
- Because it equally weighs all data points, it might not accurately reflect recent changes in the market.
- It might give false signals in volatile markets because it doesn’t adapt to market changes as quickly as some other indicators.
Example of signals
Traders often use two SMAs: a short-term one and a long-term one. When the short-term SMA crosses above the long-term SMA, it’s considered a bullish (buy) signal. When it crosses below, it’s a bearish (sell) signal.
True Positive:
In an uptrending market, the short-term SMA might cross above the long-term SMA, correctly indicating a continuing upward trend and a good time to buy.
False Positive:
Let’s say the market is in a sideways trend (prices fluctuate within a narrow range). A brief price spike could cause the short-term SMA to cross above the long-term SMA, generating a buy signal. However, this could be misleading as the overall trend hasn’t changed.
Use in Real Trading
In real trading, SMA can be paired with other indicators for better results.
For instance, a trader might use SMA in conjunction with the Relative Strength Index (RSI). The RSI could help confirm whether the market is overbought or oversold when the SMAs cross.