The Simple Moving Average Indicator Guide
The Simple Moving Average (SMA) is an incredibly useful, multi-purpose technical indicator which every Forex trader should have some degree of familiarity with.
In this article, we will explain exactly what the simple moving average is and demonstrate how to trade with it. We will show you how to use the simple moving average indicator as to identify, confirm and follow a market's trend.
Table of Contents
What Is a Simple Moving Average?
A simple moving average is the simplest form of the moving average indicator. A moving average is a mean value calculated over a specific number of recent data points. This value is re-calculated at each new data value, kicking out the oldest value in favour of the most recent period.
Let's take a look at a simple example, in order to illustrate how to calculate the simple moving average.
How to Calculate Simple Moving Average
We calculate values using the simple moving average formula:
- Formula : SMA = (Sum of price values for n periods) / n
Let's use some sample prices to show a simple moving average example. Let's say we want to calculate the 10-day SMA using daily closing prices.
The simple moving average period, n, is 10 in our example. So we add our 10 closing prices together to receive the total, and then we divide this number by 10.
- The sum of our values would be: 24 + 26 + 23 + 28 + 30 + 26 + 22 +19 +24 + 20 = 242
- Therefore, the first value of the SMA would be: 242/10 = 24.2
The next day (Day 11) we would discard our old 'Day 1' value, and instead include the newest day's closing price in our calculation, giving us a new average value.
The value of the average would continue to change with each new day and this is why it is called a moving average. To find a simple moving average is not particularly simple and, particularly for SMAs with a high number of periods, requires a lot of calculation.
Fortunately for us, thanks to advances in technology, computers can easily perform these laborious calculations for us. The majority of trading platforms, such as MetaTrader 4 (MT4) and MetaTrader 5 (MT5), come with a simple moving average indicator as standard and can almost instantaneously calculate a simple moving average regardless of the time period selected.
Using the SMA Indicator in MT4 and MT5
As mentioned in the last section, the SMA indicator is included by default in both MetaTrader 4 and MetaTrader 5, meaning that you are not required to perform a separate simple moving average download after installing your MetaTrader trading platform.
In both MT4 and MT5, you can find the Moving Average indicator located in the ‘Trend’ folder within the Navigator window, as shown in the image below.
Depicted: Admiral Markets (formerly Admiral Markets) MetaTrader 5 – Navigator
As you can see in the image above, the moving average indicator in MT4 and MT5 offers you a choice of more than one type of method. Naturally for an SMA, you choose 'Simple' as the method. The SMA settings which you need to amend are the values for 'Period', 'Shift', and 'Apply to' – each of which we will briefly explain below.
Period
The 'Period' is the same as the 'N' in our SMA formula example from earlier. It refers to how many periods we want to include in our simple moving average.
The greater the value for N, the smoother our moving average line will be, but the slower it will react to changes in the price. Smaller values for N will produce a faster-moving SMA line. It will react more quickly to changes in the price, but it will be less smooth. Ideally, we are looking for a happy medium that will be smooth enough to allow us to see beyond short-term volatility, and instead focus on genuine trends, but which is also fast enough to provide us with timely signals.
It can be useful to compare a faster (i.e. a shorter period) simple moving average with a slower (i.e. a longer period) one, as we shall see later on in the trading strategy section of this article.
Shift
The 'Shift' is the least important of the SMA settings. The value entered displaces the SMA in time along the time axis, with a positive value shifting the SMA to the right, and a negative value potentially shifting it to the left.
For beginner traders, using the default value of 0 is recommended as the best place to start.
Apply To
The 'Apply to' menu provides you with seven choices.
They include:
- Close
- Open
- High
- Low
- Median price - which is (high + close)/2
- Typical price - which is (high + low + close)/3
- Weighted close - which is (high + low + close + close)/4
The default setting applies the SMA to close and, once again, this a good place for beginners to start. Naturally, some experimentation will help you to decide on the best simple moving average settings for your particular trading style and strategy.
In the image below, a 50-period SMA indicator on an hourly chart of the GBPUSD currency pair is displayed as an example:
What Does the Simple Moving Average Tell Us?
Primarily, the SMA indicator allows traders to see beyond short-term price fluctuations and thereby perceive the underlying trends of the market more clearly.
Notice in the GBPUSD chart shown above how the SMA indicator smooths out the market movement. This allows traders to see more clearly the overall trend of the market than simply looking at price alone.
Here, we have a couple of key points for how to trade with the SMA indicator:
- We can use the price crossing above or below the simple moving average as an entry signal to buy or sell respectively
- The price remaining above or below the moving average is confirmation of an uptrend or downtrend respectively
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A Simple Moving Average Trading Strategy
The simple moving average crossover strategy is a fairly basic trend-following system. It uses two different SMA indicators – one faster and one slower - which provide a trading signal when one crosses over the other.
The direction of the signal is given by the direction that the faster SMA crosses over the slower one. So, for example, you might use a 30-period simple moving average as the fast SMA and a 100-period simple moving average as the slower one.
If the 30-period SMA crossed above the 100-period SMA, it would be a buy signal. If, on the other hand, the 30-period SMA crossed below the slower SMA, it would be a sell signal.
In the chart below, the 30-period SMA is represented by the black dotted line and the 100-period SMA is the solid blue line. Following the rules of the strategy laid out above, we can see that in the depicted timeframe, we received a buy signal on 1 July 2020, followed by a more recent sell signal on 15 July 2021.
Following such trading signals is an example of simple moving average forecasting. In other words, we are using our simple moving average indicator as a likely guide to the future performance of the market. Of course, such simple moving average forecasting relies on a key assumption - that future data values will tend to follow the trend.
However, it is important to remember that historical values will not always accurately predict future values, and there will times when the trend breaks down.
Historical data is an imperfect guide to the unknown of tomorrow, but it remains one of the few tools that traders have at their disposal.
The simple moving average trading strategy outlined above is just a basic example of how the SMA indicator can be used to generate buy and sell signals. Traders can formulate other simple moving average trading strategies by incorporating other technical indicators.
One way to do this is to use an SMA indicator as a trend filter, and then use another indicator for the trading signals. For example, you could use Keltner Channels for entry signals, buying when the price breaks above the upper Keltner Channel, or selling when it breaks below the lower channel. The filter comes into play by only following signals that agree with the direction of the larger trend.
To learn more about this particular Keltner Channel trading strategy and others which use the moving average indicator, read our other article ‘The Moving Average Strategy Guide’.
The Admiral Keltner Channels are just one of the many additional tools that you gain with the MetaTrader Supreme Edition. MTSE is a custom plug-in for MetaTrader that greatly expands the functionality of the platform – and it is free to download!
Simple Moving Average vs Exponential Moving Average
As we saw earlier from the 'Type' dropdown in MetaTrader, there are several types of moving average indicators available. The two most common are the Simple Moving Average and the Exponential Moving Average (EMA).
With the simple moving average, all data points are weighted equally when calculating its value. However, with the EMA indicator, each data point is weighted differently, with more recent data carrying higher significance in the calculation.
Because moving averages look back and incorporate older data points, they are inherently lagging in nature. Changes within a moving average will occur after the market has already started moving. This is why the chief use of the simple moving average is as a trend-confirmation tool.
Weighted moving averages attempt to mitigate the lag by placing more emphasis on recent data points, assuming that more recent data is more relevant for predicting what might happen next.
An exponential moving average weights previous data with a weighting, that exponentially decreases with time. There is a trade-off however, in that it may not smooth out price fluctuations efficiently.
When comparing an SMA to an EMA, one is not inherently better or worse than the other; it is more a question of understanding the difference, and using whichever better suits your requirements.
The best way to work out what works best for you is to test them both and a demo trading account will allow you to do this without jeopardising your capital.
Final Thoughts
In this article, we have explained how to calculate a simple moving average. We have also demonstrated how using a simple moving average smooths price fluctuations, making trends easier to spot and how the SMA indicator can be used to generate trading signals.
Simple moving average indicators can be used for all trading instruments. For instance, a stock SMA indicator will work just as well as a Forex one.
It is a very versatile tool with a variety of uses for informing us about the market trend. We hope you enjoyed this discussion of Simple Moving Averages and if you would like to learn more about Forex indicators, why not check out our article ‘Five Forex Indicators Every Trader Should Know’.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.
