Simple Moving Averages (SMA’s)
As a definition, the simple moving average is just what its name implies. An average of stock prices over a given period of time, depicted on our charts as a line graph. Each segment determined by the corresponding average price of the selected time period.
Want a more functional definition as it applies to trading?
Simple moving averages are used heavily by retail as well as professional investors. Maybe the most used indicator of them all, in some form or another. Knowing this, doesn’t it make sense to have it incorporated into our repertoire of technical analysis tools?
You bet it does!
If everyone is using this simple metric to determine profitable trading opportunities, then the moving average power is captured, not from the information it provides, but instead from the number of believers in the indicator itself.
If enough people see a point in time on a chart and believe something will happen, then usually it does.
And that my friend, is the power of moving averages! They are widely used and accepted.
Let me show you and explain further with an image. Click to Enlarge.
From the image above;
Red line – 200 period SMA
Grey line – 10 period SMA
Blue line – 30 period EMA (discussed here)
The period is the number of candlesticks used to derive the line graph and is set when applying the study to your charts. The periods can be set to whichever you wish. A smaller period represents a faster moving average line and a larger period indicates a slower line.
What can we see in the chart above?
Well the story here is multi dimensional (as is most technical analysis…or life for that matter).
- The trend is in the direction of the moving averages. Up sloping = uptrend. Down sloping = Downtrend.
- A crossover signals a reversal or continuation of the trend.
Note – Moving averages are unreliable in choppy, sideways markets.
When the moving averages separate themselves from one another and the faster of the two reverses its course to crossover the slower. It can be reasonably assumed the trend direction has changed.
This in a nutshell explains the simple moving average.
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