A moving average is used to smooth a series of values expressed as a function of time (time series). It eliminates the least significant fluctuations. Moving averages of order 9, 12, 25, etc. are calculated. The order is the number of periods (minutes, hours, days, etc.) over which the moving average is calculated. In this article, we are going to speak of Simple Moving Averages, for which each of the period’s values are taken into account equally. Other kinds of moving averages exist, such as the Exponential Moving Average or Kaufman’s Adaptative Moving Average.
How to interpret the Simple Moving Average?
The simplest way to interpret a Simple Moving Average is to compare them to the price of the asset. Since the Simple Moving Average eliminates the least significant fluctuations, it may lag below the price during bullish periods. On the contrary, it may trail above the price when the market is bearish. Hence, a simple way to interpret the simple moving average is to check whether the price is above or under it, to recognize bullish or bearish trends.
On the chart above, we are comparing the evolution of the price minute per minute to the 99 minutes Simple Moving Average in yellow. The first thing that we can notice is the smoothing power of the Simple Moving Average. The white line of the price is spiky while the yellow Simple Moving Average is smoother. We can see that the Simple Moving Average lags way behind the price when the trend is bullish. After the spike, the market is slightly bearish and the price tends to fluctuate below the Simple Moving Average.
Now, as we have seen, the curve of an asset’s price shows variations. It is sometimes better to compare the positions of a short and a long Simple Moving average to evaluate trends with more security.
On the example above, we can see the price candles, a 7-period Simple Moving Average in yellow, and a 25-period Simple Moving Average in blue. We can see that the price of the asset frequently drops below the two Simple Moving Averages. But, if we look at the two curves, we cans see that the 7-period Simple Moving Average does not clearly fall below the 25-period Simple Moving Average. It seems to bounce on the blue curve. The 7-period SMA follows the price more closely that the longer SMA, which indicates the general trend: a strong bullish one. However, at the end, the 7-period SMA clearly drops below the 25-period SMA, indicating a clear trend reversal. The market is now bearish.
How to calculate the Simple Moving Average?
The calculation of the Simple Moving Average consists in adding up the different closing prices of the stock studied and dividing them by the number of periods. Thus, if the period chosen is fifty hours, we will have to add the fifty closing prices of the stock, before dividing the number obtained by fifty. In this way, we will obtain the Simple Moving Average.
You may find below an example of the Simple Moving Average calculation.
|Close price||5-period SMA|
|132||Not enough periods|
|134||Not enough periods|
|129||Not enough periods|
|139||Not enough periods|
Technical Indicators using Simple Moving Averages
Several technical analysis indicators are built using Simple Moving Averages. They can be used with the close price of the asset, or even to smoothen signals of other indicators themselves.