Simple Moving Average


How to Calculate the Simple Moving Average

The simple moving average (SMA) is the most basic of the moving averages used for trading. The simple moving average formula is calculated by taking the average closing price of a stock over the last "x" periods.

Let's take a look at a simple moving average example with MSFT.  The last five closing prices for MSFT are:

28.93+28.48+28.44+28.91+28.48 = 143.24

To calculate the simple moving average formula you divide the total of the closing prices and divide it by the number of periods.

5-day SMA = 143.24/5 = 28.65
 

How to Make Money Trading with the SMA

Most traders will tell you to trade simple moving average crossovers of and the profits will fall from the heavens. Well, unfortunately this is not accurate. Often time's stocks will tick over or under moving averages to only continue in the primary direction. This will leave you on the wrong side of the market and down on your positions. Below are a few ways to make money trading the SMA.

Going with the Primary Trend

  1. Look for stocks that are breaking out up or down strongly
  2. Apply the following SMAs 5,10,20,40,200 to see which setting is containing price the best
  3. Once you have identified the correct SMA, wait for the price to test the SMA successfully and look for price confirmation that the stock is resuming the direction of the primary trend
  4. Enter the trade on the next bar

Fade the Primary Trend Using Two Simple Moving Averages

  1. Locate stocks that are breaking out up or down strongly
  2. Select two simple moving averages to apply to the chart (ex. 5 and 10)
  3. Make sure the price has not been touching the 5 SMA or 10 SMA excessively in the last 10 bars
  4. Wait for the price to close above or below both moving averages in the counter direction of the primary trend on the same bar
  5. Enter the trade on the next bar

Cons of Using Simple Moving Average

The simple moving average takes the raw average of the last "x" closing prices. The simple moving average formula does not weight recent price movements like its sister the exponential moving average.  Hence, the simple moving average will quite often lag the current price and should never be used to make trading decisions independently of other technical analysis indicators.