A Simple Moving Average (SMA) is the average price of an asset over a certain period of time. It is a technical indicator which can be used to determine whether the asset price will continue to rise or fall, following either a bull or bear trend.
SMA is simply the mean, average, of stock price values over a specific period of time. In order to determine this average, all a trader needs to do is take a particular stock’s closing price for a certain number of trading days and add them all together. Then, divide this total by the number of trading days.
Here’s a basic example for 5 days:
In the last 5 days, the closing prices of a company are: 69.62 + 69.48 + 70.34 + 70.80 + 71.11= 351.35
The company’s 5-day SMA is 351.35 / 5 = 70.27
Once SMAs are plotted on charts, traders gain clear visibility of the trending direction of the stock for the chosen period.
Having an SMA strategy can be particularly useful for traders as having averages plotted clearly on a chart can help them easily spot trend changes.
The simple rule for Simple Moving Averages is recognising trends. So, when a stock crosses beneath or above a moving average, it indicates whether a trader must buy or sell. Traders are looking to buy when stocks cross beneath the moving average and sell when they rise above.
There are an infinite number of Simple Moving Averages traders can use however there are some fundamental time-frames that make up the majority of SMAs.
However, the most popular used by long-term traders is the 50 SMA. As for day traders, much shorter moving averages, lasting only minutes or hours, can be more useful.