What does a simple moving average measure?
The short answer
A simple moving average (SMA) shows the average of a security’s price over a set number of past periods, updated as each new period closes.
A simple moving average is an average of a security’s data points, usually its closing prices, calculated over a specific number of periods. StockCharts ChartSchool
The line that results from this average is plotted on the same chart as price, using the same number of periods for every new value it displays.
How is a simple moving average calculated?
The short answer
An SMA is calculated by adding a set number of past closing prices together and dividing that sum by how many prices were added.
A simple moving average is formed by computing the average price of a security over a specific number of periods; for example, a 5-day simple moving average is the five-day sum of closing prices divided by five. StockCharts ChartSchool
As a new period’s closing price becomes available, the simple moving average calculation drops the oldest closing price from the window and adds the newest one, which causes the average to move forward along the time scale. StockCharts ChartSchool
In practice, this means listing the closing prices for the chosen number of periods, adding them together, dividing by that same number, and repeating the process as each new period closes.
Where did a simple moving average come from?
The short answer
Our sources do not document this.
What does published research say?
The short answer
General reviews of technical trading rules, like those cited below, can include tests of simple moving average rules; the findings quoted here do not report a separate result for simple moving average rules.
Our sources include reviews of technical trading rules in general.
A 2007 review by Cheol-Ho Park and Scott Irwin looked at 95 modern studies of technical trading rules in general: 56 reported positive results, 20 negative results, and 19 mixed results. Despite that positive evidence, the review found that most of the studies had problems in their testing, such as data snooping and difficulty estimating risk and transaction costs, and said future research must fix them before the evidence can be called conclusive. RePEc IDEAS
A 2011 St. Louis Fed working paper by Christopher Neely and Paul Weller reviewed research on technical trading rules in general in currency markets. It reported that simple rules on dollar exchange rates gave positive returns, after accounting for risk, for 15 years in the 1970s and 1980s before those returns disappeared, and that more complex, less studied rules have since produced more modest returns. Fed in Print (Federal Reserve)
How is a simple moving average commonly used?
The short answer
A simple moving average is often read as a line that shows the general direction of recent closing prices over the chosen number of periods.
A rising simple moving average shows that prices are generally increasing, and a falling simple moving average shows that prices are generally decreasing. StockCharts ChartSchool
For example, a trader might plot a simple moving average on a daily chart and note whether the line slopes up, down, or sideways to describe the recent direction of closing prices. This example is illustrative only and does not indicate typical results.
Another trader might compare the simple moving average line to the current price to describe whether price sits above or below the recent average. This example is illustrative only and does not indicate typical results.
What are the limits and common misreads?
The short answer
Simple Moving Average is calculated from past market data; it is not a forecast.
A simple moving average is based on past prices, so it tends to lag behind price, and the lag increases as the moving average’s period length increases. StockCharts ChartSchool
A simple moving average gives equal weight to every price in its lookback window, while an exponential moving average weights recent prices more heavily and therefore lags less than a simple moving average of the same length. StockCharts ChartSchool
How is a simple moving average read alongside other context?
The short answer
A simple moving average is often read next to other chart information rather than used on its own.
A trader might view a simple moving average alongside support and resistance areas or the relative strength index to add more context before deciding how to read a chart. This example is illustrative only and does not indicate typical results.
No indicator or combination of indicators makes an outcome certain. Trading involves the risk of loss.
Take it with you
- A simple moving average averages a set number of past closing prices to describe the general direction of recent price action.
- The calculation updates by dropping the oldest price and adding the newest one as each period closes.
- Because it relies on past data, a simple moving average lags price, and longer lookback periods lag more.
- No indicator or combination of indicators makes an outcome certain, and trading involves the risk of loss.
Disclosure
This article is educational content from One Purpose Trading. It is not financial, investment, tax, or legal advice, and nothing here is a recommendation to buy or sell any security or instrument.
Trading involves substantial risk of loss and is not suitable for everyone. You can lose more than your initial investment. Any examples, figures, or scenarios are illustrative only. Results are not typical, and past performance does not guarantee future results.
You are responsible for your own decisions. Trade only with capital you can afford to lose, and consider consulting a licensed professional about your individual situation.