SMA (Simple Moving Average) — Trading Indicator 101
Simple Moving average is a technical indicator used by trader all over the world for every asset possible such as equity, forex, commodity and wat not.
Basically it’s a simple average of a series of Source data. Most of the cases the default source data used in calculating the simple moving average is Close prices data set.
They are also known as Lagging indicator as the data used and the result shown is based on past price action and don't indicate the immediate future price action. That said they are critical in confirming the changes in the Price trend.
There are many ways a trade using SMA below are a few methods.
-Price Crossover with the SMA
-Multiple SMA Crossover
-SMA reversal.
-SMA for Support and resistance.
Price Crossover SMA:
The first method is using the crossing over SMA above or below as an indicator to buy or sell. When SMA crosses above the price it means that the increase of price is below average or the momentum of price increase has slowed thus meaning that price can fall further.
Similarly when the price of an asset crosses SMA its means that the price is rising faster than the average price movement thus meaning the momentum is rising in that asset price.
The key is to find the right asset when their price does the crossover and screen for such opportunities.
So does an SMA crossover always mean gains? The simple answer is no but its mean the probability is high for gains.
Many time it’s best to combine other indicators such as volume increases and RSI to help you make better decisions.
Multiple SMA Crossover:
In the previous example, we use the price change and an SMA to find when the trend is increasing or decreasing. In this example, we do that same however instead of prices we use 2 SMA, one with a smaller length known as fast SMA and one with longer length known as slower SMA.
The theory is the same previous however the smaller SMA smoothen the price curve remove minor irregularities caused due to random price action.
When the fast SMA crosses above the slow SMA it means that the price might start to raise as the momentum is increasing and if it cross below then the opposite is true and the price momentum is decreasing.
One example of this is “Golden Crossover” it’s a famous crossover using SMA 20 and SMA 50.
Longer SMA with 200 lengths is used as for long term trend confirmation.
SMA reversal :
Most of the time SMA is used when there are raising or falling to get in and out of trading asset but it’s key to focus on the time when these SMA reverse their direction. Many experience trades keep an idea on these are a normal crossover happened after a reversal and its a known point for many to enter the market but less profit when compared to a successful entry at reversal. There entry like all entry should be done with a stop-loss and risk management.
The “U” shape curve made during the reverse is early indication of trend changes.
SMA support and resistance :
Many experienced price action trader and don’t use SMA for simple buy and sell instead there use it as support and resistance. Normally support and resistance are a horizontal line of a chart but aren’t dynamic and need constant updating. SMA act as a dynamic line which changes and evolve as the prices as updated.
There S&R are physiological barriers that help in making trend is follow until it eventually breaks.
In addition to the above method of using SMA, there is many more ways to make use of it for example by plotting two SMA line using high price and low price trade can get an SMA band which they can use to do trades.
Another example is to plot two SMA using open and close price as a source and performing the crossover of the two-line to make buy or sell call.
These are only a few examples,there are many way people use SMA in personalized way.
Out the many disadvantages of SMA is 2 main are the laying aspect and not being effective at lower time frames.
To overcome the delay part of SMA, EMA is recommended as the formula for EMA put more weight to the latest price hence more responsive.
Also, it's recommended to use SMA mostly for higher time frames such as daily and above to avoid various fake signal and noise.
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To see a further example of how the indicator can help you make money and save you time read the following post
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