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What Is The SMA?

The simple moving average (SMA) is a popular technical analysis tool. The simple moving average is a lagging indicator because it is based on past price data. The longer the time period of the SMA, the greater the lag. While the SMA is a helpful technical analysis​ tool, it is best used along with other popular indicators such as trendlines and volume analysis.

In most trading scenarios, the SMA is plotted on a price chart along with the exponential moving average (EMA). They share similarities and differences but, like most technical indicators, they work best together to define price trends and momentum in trading.

Trading with the SMA shows the average price of a security over a certain length of time and is plotted as a single line on a candlestick chart​. Because it is customisable over different time horizons, the SMA is used by both short-term traders and long-term investors. 

A bullish & bearish indicator 

How To Use SMA?

There are two main ways to use the simple moving average. The first is trend analysis. At a very basic level, traders and investors use the SMA to assess market sentiment and get an idea of whether the price of a security is trending up or down.

The basic rule for trading with the SMA is that a security trading above its SMA is in an uptrend, while a security trading below its SMA is in a downtrend. 

For example, a security trading above its 20-day SMA is thought to be in a short-term uptrend. In contrast, a security trading below its 20-day SMA is thought to be in a long-term downtrend. By analysing the SMA, the investor or trader can quickly assess market trends and determine whether the security is trending upward or downward.

Simple moving averages can be useful in spotting trend changes. They can also be used to identify support and resistance​ levels. Often, during a trend, the SMA will provide a dynamic level of support or resistance. For example, a security in a long-term uptrend may continually pull back a little, but find support at the 200-day SMA. This can also be helpful in identifying trend changes. This method can be used across many markets, including foreign exchange, indices and stock markets.

50-day & 200-day SMA

What's The Difference Between SMA And EMA?

The simple moving average is the simplest type of moving average. It is calculated by adding up past data points and then dividing by the total number of data points. While the SMA is a very popular technical indicator, it does have one main weakness. Some traders and investors believe that it is flawed because every data point has the same weight. They argue that current data is more important than previous data and should therefore have a higher weight. As a result, some traders and investors prefer to use another form of moving average, known as the exponential moving average (EMA).

In comparison to the SMA, the exponential moving average gives more weight to the most recent prices. This is the key difference between the SMA and EMA. The EMA is more responsive to the latest data than the SMA, because the latest data has a larger impact on the calculation.

Golden & Death Crosses

Simple Moving Average Strategy

There are many different trend-based strategies involving the simple moving average. Two of the most popular signals that traders look for are bullish crossovers and bearish crossovers.

A bullish crossover occurs when a security’s price moves back above the SMA after being below it. This action signals that the downtrend or correction is over and a possible uptrend is starting. A bullish crossover can be used as a signal to enter a long trade. During trending markets, this signal can be quite reliable. However, during choppy or sideways markets, the indicator can be less reliable in measuring market fluctuations. Bullish crossovers are less important when the long-term trend is down.

A bearish crossover occurs when a security’s price falls below the SMA after trading above it. This action signals that the uptrend is over and the trend may now be downward. A bearish crossover can be used as a signal to exit a long position or, alternatively, enter a short position. During choppy or sideways markets, a bearish crossover is less meaningful.

Death Cross = Bearish

SMA Crossover

Another popular strategy with the SMA is the moving-average crossover. This occurs when a short-term SMA crosses over a long-term SMA. A moving average crossover is often referred to as a golden cross or death cross.

A golden cross occurs when a security’s short-term SMA crosses above its long-term SMA. For example, the classic setup here is when the 50-day SMA crosses above the 200-day SMA. This is a bullish signal and indicates that the price of the security may continue rising. A golden cross can be used as a trading signal to enter a long trade.

The reverse of the golden cross is a bearish indicator known as the death cross. A death cross is identified when a security’s short-term SMA crosses below its long-term SMA. For example, the 50-day SMA might cross over and fall under the 200-day SMA. This is a bearish signal and indicates that the price of the security may continue falling. A death cross may be used as an exit strategy.

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