Moving Average and Simple Moving Average



What is a Moving Average and a Simple Moving Average?

A moving average or MA in short, is a type of indicator widely used by technical analysts to help smooth out price data. It is created by calculating the average closing price of an asset or currency pair over a certain number of periods. Since the moving average is based on the previous prices, it is a lagging indicator or trend-following indicator.

A moving average indicator is like any other indicator, used to assist a trader to predict future prices. You can determine where the market prices will likely be heading just by looking at the slope of the moving average.

As mentioned earlier, moving averages smooth out price action. There are various types of moving averages and all of them do not have the same level of smoothness. The moving average will be slower to react if it is smoother but it will be faster if choppier. You should get the average closing price over the longer time period in order to make a smoother moving average.

Simple Moving Average Indicator

Simple Moving Average Indicator

The Simple Moving Average (SMA) is one of the two most popular types of moving averages that are constantly being used and the other one is the Exponential Moving Average (EMA). Both these moving averages are used to pin point the trend direction including the possible support and resistance levels. Although the moving averages are useful enough independently, they also act as a stepping stone for other technical indicators such as the McClellan Oscillator and the Bollinger Bands. The chart on the right shows a sample of the SMA (blue line) on a 10 days period.

Simple Moving Average Calculation

In the forex analysis, the simplest type of moving average is the SMA. It is calculated by summing up the last number of the period’s closing price and then divided it by that number of period. For example, a 5-day SMA is the 5 days closing prices all added up and divided by 5. An average called ‘moving’ because it continuously recalculate as new data are available, it keeps on running by discarding the old data and taking in the new one. For illustration, below is a 5-day moving average produced over three days:

Value of the Daily Closing Prices: 20, 21, 22, 23, 24, 25, 26

Day 1 of the 5-day SMA: (20 + 21 + 22 + 23 + 24) / 5 = 22

Day 2 of the 5-day SMA: (21 + 22 + 23 + 24 + 25) / 5 = 23

Day 3 of the 5-day SMA: (22 + 23 + 24 + 25 + 26) / 5 = 24

Day 1 of the moving average comprises the previous five days. Day 2 of the moving average discards the first data value (20) and takes in the new data value (25). Day 3 of the moving average continues by discarding the first data value (21) and taking in the new data value (26). As indicated above, values gradually increase from 20 to 26 over a period of seven days. You will notice that the SMA also increases from 22 to 24 over a calculation period of 3 days. Furthermore, each SMA value is just beneath the previous price. For instance, the SMA for day one is 22 and the last price is 24. Prices before the four days were lower resulting in the lag of the moving average.