he simple moving average is the most commonly used type of moving averages, which can be partly because of its elementary method of calculation.
Simple moving averages (SMAs) are calculated by adding the prices for the period you have selected and divided the sum by the number of periods.
Guess what? The trading software will automatically do the calculations for you, as alwayss.
But don’t be lazy, we insist on teaching you how to calculate them by yourself.
This way you can edit and tweak the indicator, in order to create different strategies as the market environment changes.
How to calculate the Simple Moving Average (SMA)?
Let’s suppose that we want to calculate a 10 period simple average of a 1-hour chart, you should sum up all closing prices for the last 10 hours and then divide it by 10.
The formula looks like this:
Simple moving average = (sum of price values for N periods) / N.
You can do the same thing on a 30-minute chart.
Add up the closing prices of the last 300 minutes(300=10×30, if we use the same 10 periods SMA) and then divide that number by 10.
It is important to know that the moving averages operate with a delay.
Because you are taking the averages of past price history, you are really only seeing the general path of the recent past and the general direction of “future” short-term price action.
Below you will see an example of how moving averages smooth out the price action:
You can plot different SMAs on the same chart at the same time as we did above on our 1-hour chart of USD/CHF.
Look at the longer SMA period (62 SMA), its reaction to the price is the slowest of the three SMAs.
The reason is that the 62 SMA adds up the closing prices of the last 62 periods and divides it by 62. The longer the period is, the more it lags behind the price.
The longer your cat’s tail is, the slower the cat will be getting out of the room and closing the door.
The SMAs shows the overall market sentiment of your chosen period of time.
In our chart, the pair is trending up.
Only looking at the current price of the market won’t give you deep insights into its future direction.
If you want to gauge the general direction of the future price, you will use SMAs.
Like trend lines, the slope of moving averages reflects the strength of the current trend. In some cases, moving averages are perceived as automated trend lines.
A pair can be trending up, trending down, or just ranging.
The widespread practice is to use 3 types of simple averages – short-term (5-day), medium-term (20-day) and long-term (200-day). This way you can get a better idea of what is the tendency on the market.
SMAs’ biggest disadvantage is that they are predisposed to spikes.
This can lead us to the appearance of false signals.
We have a solution to this problem. Check it out in our next lesson!