What Is A Good Simple Moving Average? How Do You Calculate Simple Moving Average?

Times would come when you would need to do some technical calculations to determine just how well your investments are doing in the foreign exchange market. One of those technical calculations is moving averages. Moving averages are generally what investors and traders use to understand how a trend is faring. It's called a moving average because you guessed it, it's always moving. By always moving, we mean it is always recalculated continuously after the latest price data has been taken into consideration. Look at it as a kind of prediction. Forex experts use a moving average to determine the direction of a current trend by calculating and evaluating the previous price and action of said trend. This is then used to calculate the potential direction of the asset price. In other words, moving averages help forex investors and traders produce trading signals. It tells them when to close a trade and when to open it. While there are two types of moving averages such as simple moving average and exponential moving average, what we're going to consider for most of this article is going to be simple moving average, also known as SMA

What Is Simple Moving Average

A lot of traders calculate the simple moving average because it's easier to construct. The simple moving average is simply known as the average price of a trade over a particular time. As said earlier, the word "moving" means the way it's plotted on the chart refers to the way the trade progresses as time goes on.

The simple moving average is a technical indicator that's calculated by summing up the previous plot points in a given set and then dividing the whole set by the number of periods. Before we proceed to how a simple moving average is calculated, let's talk a little bit about how this indicator works exactly

- SMAs are often used to determine the future of a trend. If the SMA of a trend is moving up, it means the trend is progressing and is up but if the reverse is the case and the SMA is down, it means the trend itself is going down.

- There are times when two different SMAs can cross paths. This often produces some kind of alarm in the trading indicators. Most of the time, a short period SMA can cross over a long period one. When this happens, it's a signal for you to go long. However, when it's becoming apparent that the short period SMA will cross below the long term SMA, it's advised you go short or close the trade like that.

- Short-term averages, most of the time are quick to react to changes in the price of the underlying security. Long-term averages on the other hand respond slowly to these changes.

- It's important to know that the time value is incredibly important when using the SMA. The longer the simple moving average of a trend, the easier the result, although there may be a few complexities along the way.

In other words, the Simple Moving average is used to track the progress of a particular stock. When traders do this, they often ignore the daily price movements of the stock. You can say these traders are looking at the big picture rather.

How To Calculate: Simple Moving Average Formula

To start on a simple note, to calculate a simple moving average, you divide the number of prices of a particular stock in a period by the number of periods. Let's say the shares of XC for 6 days were $2, $5, $7, $3, $4, $6. Calculating the simple moving average would mean the addition of these numbers and then dividing them by the number of days (which is 6 in this instance) this would mean $2+$5+$7+$3+$4+$6 divided by 6 would total $4.5. The $4.5 is the SMA. If the stocks of XC span 15 days, you would do the same, calculating the closing prices week by week. If the stocks span a period of 50 or 70 days, the same kind of calculation would be applied. This then brings us to the formula for the calculation of the SMA

= A1 + A2 +....An

SMA ___________________

In this instance, however, An is the price of the stock at period n and n is the total number of the periods.

Sometimes, these trades do not only apply to days. They apply to minutes and hours as well. Let's say, you plotted a 5 period average on a 20 minutes chart, you would multiply the period average with the minute chart and then divide the number by the period itself. Let's make this easy.

Let's say on a 20 minutes chart, XCs stock was plotted in 5 periods. We would add up the stock prices for the past 100 minutes and divide them by 5.

How To Use Moving Averages

Now that we're clear on how to calculate SMAs, what's next is how to use them. This section in particular would talk about how to use moving averages in general.

From this point, you should know that there are several ways in which moving averages are used. For some investors, some ways are preferred over others. We'll discuss some ways below and it's up to you to choose whichever one you would like.

Analysis

Moving averages are often used to analyze a trend. There are different kinds of combinations a trader or an investor can use in analyzing a trend but the one we would recommend is the 10 EMA and the 20 EMA. It's the personal favorite of some expert investors and has been proven to be useful over time. Other traders use other numbers such as 10, 20, 100, 50, 200, and so on. At this point, it's important to know that sometimes, using a MA to analyze a trend might not give you the perfect result but if it's used accordingly, these combinations would make your analysis of a trend simpler.

Identifying Markets

Moving averages are also used sometimes to identify markets and determine if they are overextended. Moving averages, when used properly can help traders by preventing the late sales or late purchase of a stock. The last thing traders want is to buy or sell too late. When MAs are used to identify overextended markets, it would prevent the traders from joining the trend too late.

Support And Resistance

The third thing MAs can help you with is support and resistance trading. They can also help you stop placement. Let's go back to the number combinations mentioned earlier. The market reacts accordingly to these numbers because they are mostly used by traders and investors. In other words, MAs help you know which trade would react to your combinations due to its general use.

Simple Moving Average V Exponential Moving Average

While simple moving average is easier to calculate and analyze, the exponential moving average is much preferred by traders, why, you ask? The major difference between these two moving averages is their sensitivity analysis. Don't worry, you'll know more about this as you read on. We'll break it down for you.

While a simple moving average gives an equal answer to every value within the period, the exponential moving average tends to be more timely. This is due to its advanced calculations. It adds more weight to the recent values which in turn makes prices react easily. An exponential moving average, when properly calculated, tends to respond faster than a simple moving average.

The exponential moving average can be more complex with its calculations but since unlike the simple moving average which provides some kind of equal weight to all prices leading towards the current value, the exponential moving average provides more sensitive values, making it much more preferred by traders. Although the EMA is preferred to the SMA, you must know that it does not make the former necessarily better than the latter in any way. For example, in the case of an economic fluke in the forex market, the faster moving MA, (exponential) would make the person close trade quickly so he doesn't amass losses. The slower moving MA (simple) on the other hand would not react quickly, thereby making the trader stay in business and amass more profits.

Well, everyone, that's all to know about the simple moving average and how to calculate it. While it is said that an MA is not necessarily better than the other, a trader has to carefully analyze the two and determine which one would be best for his strategy. A lot of short-term traders prefer the EMA because they want to know as soon as possible when the values of a stock are going sideways. Long-term traders on the other hand prefer to use the SMAs since they aren't planning on leaving the trade anytime soon. It's up to you to determine which one you are. They are both great in their own ways. It just depends on the way you plan to use them in your trading strategies.