SMA stocks are among the most crucial core indicators in stock analysis. It’s one of the many types of moving averages. Therefore, many new investors often look at it to help visualize stocks and make the right decision.
Read on, and find out more about SMA in stocks. We’ll define the concept, so you can better understand how to use it in trading. In addition, we’ll also look at how it’s different from an exponential moving average.
What is SMA?
In a nutshell, Simple Moving Average shows the average prices within a specified range. Further, it often indicates closing prices. Meanwhile, it aids in the identification of whether an asset will continue to increase or decrease over time. It can also show if there will be a reversal of a bull or bear trend by looking at current and historical prices.
More so, SMA is an arithmetic moving average. You’ll calculate it by adding recent prices and dividing it by the number of periods you’re trying to cover in the calculation. It’s customizable since you can calculate different time periods.
Another thing worth pointing out about SMA is that it smooths out volatility. Not to mention, it gives an easy view of the trend in prices. If it points up, the price is increasing. On the other hand, pointing down means the price is decreasing.
How Does SMA Stock Indicator Works?
As noted above, an SMA stock indicator works by considering two main factors. First, it looks at the prices. Second, it considers the time period. For example, it can look at the prices daily over the last ten days or the last 200 days.
The SMA indicator can give you an idea of your next trading strategy. For instance, many people will use it for timing their move. Meaning it can help determine when it’s time to buy or sell.
More so, SMA in stocks is vital for trend-following. In case you don’t know, trend followers are those who buy stocks when they trend up and sell those on a downtrend. Quite literally, they follow the trends. Hence, the SMA indicator is one of the tools they use to determine their next move.
What Does SMA Mean in Stocks?
Now that we talked about the meaning of SMA in general, it’s time that we discuss what is SMA in stocks. Well, if you already know the basic concept, it’s easy to understand SMA stocks meaning.
SMA is the average closing price of a specific stock within a period. “Moving” in its name refers to the constant changes a stock experiences over time. Further, it’s one of the most vital tools for technical analysis. As such, it can help in the prediction of the future price using available market data as the basis.
More so, SMA could mean support or resistance, which is another way by which it can aid in trading decisions. If it’s at a support level, it can hinder a decrease in price. Consequently, if it’s at a resistance level, it can hinder an increase in price.
Lastly, the movement can determine your strategy. For instance, a lot of traders will cover short or go long if the SMA crosses above the stock price. Alternatively, if the price crosses below the SMA, most will exit long or go short.
Simple Moving Average vs. Exponential Moving Average
Earlier, we already discussed the meaning of SMA stock. Now, we’ll compare it to Exponential Moving Average. By doing so, you can decide which one is a better tool for making better trading decisions.
EMA is like SMA in the sense that they both measure trends over a certain period. However, the main difference is when it comes to how they do so.
In the case of SMA, the calculation depends on the average price. On the other hand, EMA puts more weight on the current price instead of factoring in average prices. Hence, the latest price data will have a bigger influence on EMA. In contrast, the oldest price will have more impact on SMA.
And because EMAs put more emphasis on recent prices, they are more reactive to the latest changes. Hence, most traders prefer using EMA over SMA in informing their next trading strategy.
Traders with short-term perspectives will rarely look at average prices. In many cases, the differences between the averages are only by a few cents. Meanwhile, looking at EMAs will let you consider values by a few dollars.
Nonetheless, while others may prefer EMAs over SMAs, it’s not a guarantee that one works better than the other. In fact, none of these indicators will ensure trading success. Instead, you should only look at them for guidance along with many other factors.
How to Use a Moving Average to Buy Stocks
Now, how can you use EMA and SMA stock in real life? It shouldn’t just be a technical concept, but it must be an indicator that you can actually take advantage of.
Among others, one of the ways to use moving averages when buying socks is for cutting noise. It helps you to focus on more important factors, such as price action. In addition, it makes data smoother. And because of this, it’s easier to spot trends by simply looking at the direction of the moving average.
In addition, you can also use moving averages for confirming both uptrends and downtrends. When a stock’s price is higher than the moving average, it can be a sign that it trades at a higher price during a certain period.
More so, moving averages can work with other indicators to act as more comprehensive trading signals. For instance, it can result in a golden cross, which a lot of traders consider a sign of a major rally.