A line on the chart which indicates what is the average price at any given time. It is definitely the most basic and commonly used tool technical analysis has to offer.
Why should I use the Simple Moving Average?
A simple Moving Average can help you to spot the current trend and to recognize a possible change in trend, it can also point out possible levels of support and resistance. These, however, are just the most basic uses of SMA. As you become more and more familiar with this indicator, you will find out that there are endless possibilities to use it, and they reach for as far as your imagination and creativity can take you.
How does it look like?
The Simple Moving Average is composed out of one dynamic line drawn over the chart. The line shows you the average price for any time period in the past and present.
How dose Simple Moving Average work?
We call it a moving average because it is moving together with time, constantly changing the average price with every new time unit.
In order to use the SMA you need to choose which time period you would like for calculating the average. If you open a 1 hour chart of USDJPY and then choose a Simple Moving Average of 10, the chart will show you the current average price of the last 10 hours. If you open a daily chart of USDJPY and then chose a Simple Moving Average of 10, the SMA line will show you the average price for the last 10 days.
Let’s observe a few simple ways you can use a SMA in your trading:
Spotting a trend
When the SMA is constantly moving up, the market is in an up trend and the price is most likely trading above the SMA. If you believe the trend is going to continue, use the opportunity to buy when the price is correcting back to the SMA line. Conversely, when the SMA is moving constantly down, the market is in a downtrend and the price is trading under the SMA line. You can use the corrections back to the SMA as sell opportunities.
Notice that when the SMA line is moving sideways, it means the market is not in a trend, but rather in a range.
Spotting a change in trend direction – the “Cross Over” strategy
This is a very popular strategy which uses two moving averages with different time periods to find out when a change in the market’s directions is likely to happen. For instance, open a chart and place two Simple Moving Averages on it. A short one of 10 periods, and a long one of 21 periods (you can choose any time periods you think are best).
Every time the short simple moving average of 10 (10SMA) is crossing the long SMA of 21 (21SMA) from below upwards, this will indicate a possible new up trend, and a buy signal. Every time the 10SMA is crossing the 21SMA from above downwards, this will indicate a possible new downtrend, and a sell signal.
Example for the Simple Moving Average
In this USD/JPY chart with a simple moving average, the market is first trending in a down trend. When the price finally breaks clearly above the SMA, it is an indication that the down trend is over, and a new uptrend is now forming. Notice how prior to the break, the SMA serves as resistance to the price and after the break above, it serves as support.