SMA - Simple Moving Average

Updated: 2024-03-12

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.

MinuteOpenHighLowCloseSMA
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: 1. Minute 1-5 close prices: $10.0, $12.0,$15.0, $14.0,$16.0
2. 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.