One of the most straightforward tools in an investor’s toolkit is the simple moving average (SMA).
The SMA is a fundamental technical indicator that smooths out volatility from price data to help identify market trends. Traders and investors use it to find more objective signals on when to enter or exit a position.
In this guide, we’ll explain how an SMA works, how it’s calculated, and how to interpret it.
Understanding Simple Moving Average
A simple moving average calculates the average of a set number of asset past prices over a defined time frame. You add up the price values over that range and divide by the number of periods.
The “moving” aspect comes from recalculating the average as new data becomes available, by dropping the oldest price and adding the newest, one period at a time.
An SMA usually uses closing prices, but it can also be based on highs, lows, or opening prices. Intervals may be hourly, daily, or even minute-by-minute. Common time frames include 5, 10, 50, and 200. SMAs are plotted directly over a security’s price chart.
Calculating Simple Moving Average
The simple moving average formula for computing an SMA is: SMA = (P₁ + P₂ + … + Pₙ) / n
Where:
- Pₙ = price at observation #n
- n = total number of observations
For example, to calculate a 10-day SMA using these daily closing prices: 10, 13, 15, 11, 12, 15, 17, 18, 20, 22
- SMA = (10+13+15+11+12+15+17+18+20+22) / 10 = 153 / 10 = 15.3
- If the next day’s price is 20, you drop the first price (10) and add 20:
- New SMA = (13+15+11+12+15+17+18+20+22+20) / 10 = 163 / 10 = 16.3
An increasing SMA suggests the market may be in an uptrend. When it decreases, that suggests a downturn.
What Does the Simple Moving Average Tell You?
By smoothing the volatility out of price fluctuations, an SMA gives you a clearer picture of a trend’s direction and strength.
- A positive slope suggests upward momentum
- A negative slope indicates a downtrend
- A flattening slope may reflect weakening momentum or trend reversal
The steeper the slope, the stronger the trend. As momentum fades, the SMA flattens. If the slope changes direction, it may signal a potential market reversal.
Drawbacks of the Simple Moving Average
The biggest drawback of an SMA is that its forward-looking value is limited. It’s based solely on past price data, which makes it a lagging indicator because it reacts to price moves but doesn’t predict them.
Another limitation is equal weighting. Each price in the calculation is weighted the same, which can overemphasize older data and underemphasize newer movements, especially in fast-moving markets. That’s why some investors prefer to use an exponential moving average (EMA) instead.
Simple Moving Average vs. Exponential Moving Average
While the SMA assigns equal weight to all data points, the EMA places greater emphasis on recent prices.
Both indicators are interpreted similarly and used to smooth volatility, but an EMA responds more quickly to recent changes. That sensitivity makes it a preferred tool for more active traders.
How to Use Simple Moving Averages
Most trading platforms and charting tools let you add SMAs to price charts with a few clicks.
Once you’ve selected your asset and chart, add the SMA indicator and choose your timeframe (e.g., 10-day, 50-day). Customize the line color if needed for visibility. From there, monitor the SMA’s slope and position relative to price action as part of your technical analysis strategy.
Frequently Asked Questions
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Popular SMAs include the 10-day (short-term), 50-day (intermediate), and 200-day (long-term). The time frame depends on your trading strategy.
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It shows the average price over a specific time period, helping to smooth out volatility and identify prevailing trends.
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Both track trends, but the EMA gives more weight to recent prices, making it more responsive to current price movements. SMA gives equal weight to all data points.
