The financial market calls it moving because of its shape on the chart. As the average value increases or decreases, it forms a moving line.
A simple moving average forecast can be for any number of trading days. However, the most common periods are 50 and 200 days. As such, 50 days is a quarter of a trading year when you skip the weekends and holidays. On the other hand, 200 days is around the total trading days you can have in a year.
But you can also calculate the average for hours or weeks. It all depends on the reason for finding the average price.
Why Use The Simple Moving Average
Lower Stock Price Volatility
This average isn’t just a figure; it helps traders identify price points of stock, futures, or other investments. Hence, it smoothens price data. It reduces the volatility for a clearer picture of the price trend. The result is even smoother when calculating the average over a long period.
However, this may increase the lag between the source and the simple moving average. That’s why some traders use the exponential moving average instead. The difference is that the latter uses recent prices rather than the average over a specified period. Therefore, a trader who uses it depends on a more timely trend.
Calculating the average stock price over a specific period shows you the trend direction. It can be moving up or down. Therefore, when the average value moves up, it shows you there’s an uptrend. If it moves down, the price has a downtrend.
On top of that, the average can also show you the breakout point. As such, you follow how long the stocks stay above or below the average price.
How to Use Simple Moving Average in the Market: 2 Strategies
Trade at Moving Average Intersection
It’s as straightforward as it sounds. A trader analyzes daily prices to see where the average price intersects with the stock price. Hence, such a trader can buy when there’s an uptrend. When the chart shows a downtrend, it’s time for the investor to sell.
But there’s a downside to investing based on SMA technical analysis. That’s because you’ll make your trade decisions based on old data that’s lagging and can be misleading.
This technical indicator can help traders find an entry or exit point. As such, it’s time to sell stocks when the short-period moving average crosses and increases over the long-term average. On the other hand, if the average value in the short-term goes below the long-term one, it’s time to sell. Following this trend helps such traders reduce and manage stock risks.
Simple Moving Average Example
There’s a simple moving average formula. You know it already if you know how to calculate the mean in basic math. It adds up the prices over X days and divides the figure by the number of days in that period.
Here’s a simple moving average example using that formula. Let’s say you want to find the average price of stock X in the last five days. Hence, you add up the closing prices of those five days and divide the number you get by five.
For instance, let us say the closing prices from day one to five were $10, $11, $11.5, $10, and $10. Therefore, you calculate the moving average as ($10 + $11 + $11.5 + $10 + $10)/5. The average from these closing prices is $10.5.
If doing all this sounds like too much work, you can skip the manual calculations and use data from your broker. It might be the best option when dealing with a large volume of data, say 200 days.