Unlocking Profitable Trades: Technical Analysis using Simple Moving Averages (SMA) in Financial Analysis.
Introduction to the Simple Moving Average (SMA)
The Simple Moving Average (SMA) is easy to calculate
There are many different moving averages and calculation methods among trend-based technical indicators. This article explains the most basic calculation method for simple moving averages.
As its name suggests, a moving average is an indicator that takes the average prices over a certain period and averages them out. The SMA is calculated by adding up the closing prices over n periods and then dividing by n. It will calculate the most recent n period and track the change in the calculated value for each day (daily line). The SMA is commonly used to smooth out short-term fluctuations and highlight longer-term trends or cycles in the data.
[Table 1: Calculating the SMA]
The table illustrates how the SMA is calculated over a five-day period (5SMA).
The table above illustrates how the SMA is calculated over a five-day period (5SMA). Divide the 5-day closing values by 5; the resulting value is shown in the "5SMA" column.
The average of the values highlighted in the table above as 5SMA corresponds to the values for the same period. The calculation continuously removes the earliest data and adds the latest data. The calculation itself is quite simple.
The SMA provides a clear picture of market movement
A moving average aims to smooth out price movements by taking the average price over a given period. This makes the price movement easier to see. Chart 1 shows two SMAs, namely 5SMA and 20SMA for two different periods.
The 5SMA (blue line) moves up and down, following the candle pattern, while the 20SMA (red line) moves more smoothly. Looking at the 20MA trend, it shows a clear upward turn after a slow decline.
[Chart 1: Two moving averages] - 5SMA (blue) 20SMA (red)
As you can see, the nature of the MA varies for different period (parameter) settings. The MA running over a short period reflects the recent trend because there are fewer prices to average. This helps identify the initial movement in a trend, but as trends are more sensitive to the short-term price movement, this is a disadvantage.
By contrast, with more prices to average out, the MA over long periods is less affected by recent price movements, with the overall trend slowly reflecting price changes. The disadvantage is that it is hard to determine the initial movement of the trend. Still, it can reflect the price direction, so it has the advantage of reducing the risk caused by price changes in the short term.
Both short- and long-term periods have their pros and cons. By understanding them, you can learn which MA period to use for your analysis.
[Chart 2: Three moving averages] - SMA (blue), EMA (red), LWMA (green) Overall period: 20 bars.
Improve the MA application for price tracking
As its name implies, the simple moving average (SMA) is derived from straightforward calculations, providing a smoothed average over a specified period and offering a less reactive response to short-term price fluctuations. For enhanced effectiveness, consider complementing SMA analysis with other technical analysis.
For example, the standard functions of MT4 (Meta Trader4)/MT5 (Meta Trader5) - exponential moving average (EMA) and linear weighted moving average (LWMA), -are sensitive to price changes and help identify trend changes early on.
In chart 2, the LWMA (green) > EMA (red) > SMA (blue) indicate the uptrend in the second half of the chart.
