What is a Simple Moving Average?
A Simple Moving Average (SMA) is an arithmetic moving average calculated 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. SMA is basically an average stock price over a period of time.
How does it work?
To calculate the simple moving average formula, add up the closing prices and divide it by the number of periods.
E.g. if the closing price of an “X” Stock for the last 5 days is 20,22,24,21,23
Then 5 day SMA would be 20+22+24+21+23 / 5 = 22
The simplest form of using a simple moving average in analysis is using it to quickly identify if a security is in an uptrend or downtrend
If a shorter-term simple moving average is above a longer-term average, an uptrend is expected. On the other hand, a long-term average above a shorter-term average signals a downward movement in the trend.
Key points to remember:
- A 5-day simple moving average is the five-day sum of closing prices divided by five.
- When price is in an uptrend then the moving average is in an uptrend & Vice Versa.
- A trader has to be careful since there are an unlimited number of averages you can use and then you throw the multiple time frames.
- Two basic rule of SMA are:
A) if the price is above SMA line, it’s a bullish signal.
B) If the price is below SMA line, it’s a bearish signal.
- SMA works better in longer period’s averages. E.g. 10,20 & 200 days. Longer the period, better the SMA.