Riding the Trend: Mastering the Simple Moving Average (SMA)

The average of prices or values over a certain number of days or periods is a simple moving average. There are several moving average types. It is a financial market technical indicator.

Plotting the average or SMA values in an asset price chart forms the SMA line. The SMA line advances across the chart as new average values are drawn. Using simple moving averages (SMA) on asset prices within a range helps traders identify patterns, check price movements, and pinpoint entry and exit locations.

Different moving average types

Moving averages can be calculated in several ways. A five-day simple moving average (SMA) is computed by adding the five most recent daily closing prices and dividing by five. A new average is calculated daily. Each average is linked to the next, forming a flowing line.2. The exponential moving average (EMA) is another popular moving average type. More weight is given to current prices, making the process more difficult.

Different MA kinds are not better. Sometimes a simple moving average (SMA) outperforms an exponential moving average (EMA) in a stock or financial market. Moving average efficacy (regardless of kind) is strongly correlated with time frame.

Simple Moving Average Learning

The chart above shows Amazon’s stock price (NASDAQ: AMZN) over a year using a 50-day simple moving average. The purple line shows the 50-day simple moving average (SMA) and price trend. Since it is an average of data over a given time period, the simple moving average (SMA) does not react as strongly as actual prices.

The concept will be observed at February 2020 earnings announcements. Amazon delivered strong profits, which drove its stock price to open at $2,000, but the simple moving average (SMA) only increased slightly.

Trading Strategies: Market Combination

Crossovers are crucial moving average methods. The first type of price crossover occurs when the price crosses above or below a moving average, indicating a market trend change.

Another option is using two moving averages, one longer and one shorter, on a chart. The shorter-term MA crossing over the longer-term MA signals a buy. Because it indicates an upward trend. People call it a golden cross. When the shorter-term MA falls below the longer-term MA, a sell signal is generated. Because it shows a declining trend. A “dead” or “death.”

Instrument for Trend Confirmation

Traders use the simple moving average to determine if a security’s price is rising or falling. The fundamental concept for trading with Simple Moving Average (SMA) is that an asset in an uptrend is trading above it. A security trading below its simple moving average is in a downtrend. A short-term uptrend occurs when a securities trades above its simple moving average for 20 days. A security trading below its 200-day simple moving average indicates a long-term decline.

Another analytical technique is comparing two simple moving averages from different time periods. When the shorter time period moving average is bigger than the longer time period moving average, an upward trend is expected. If the longer-term moving average is higher than the shorter-term average, a downward trend is expected.

Controlling Risks

Risk management is improved by the Simple Moving Average technique since it can spot market trends and reversals. Active traders can use this chance to tactically limit losses, protect investment money, and create precise stop-loss orders based on simple moving average levels.

Limitations of the Simple Moving Average

Although the basic MA is a useful trading indicator, its constraints must be considered. The indicator may give false indications and cause price spikes.

According to QuantStrategy, Because it weights all prices equally, the simple moving average (MA) cannot distinguish between high- and low-volatility prices. However, such data may reveal market trends. It is slower to react to trend reversals, thus traders use it for trend confirmation rather than forecasting.

Shorter-term averages may be erroneous due to the velocity of short-term movements. Because a moving average does not tell you what a big movement is, you must examine the price-average relationship.

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