A simple, or arithmetic, moving average that is calculated by adding the closing price of the security for a number of time periods and then dividing this total by the number of time periods. Short-term averages respond quickly to changes in the price of the underlying, while long-term averages are slow to react.
In other words, this is the average stock price over a certain period of time. Keep in mind that equal weighting is given to each daily price. As shown in the chart above, many traders watch for short-term averages to cross above longer-term averages to signal the beginning of an uptrend. As shown by the blue arrows, short-term averages (e.g. 15-period SMA) act as levels of support when the price experiences a pullback. Support levels become stronger and more significant as the number of time periods used in the calculations increases.
Generally, when you hear the term “moving average”, it is in reference to a simple moving average. This can be important, especially when comparing to an exponential moving average (EMA).
Another example is that the simplest form of a moving average, appropriately known as a simple moving average (SMA), is calculated by taking the arithmetic mean of a given set of values. For example, to calculate a basic 10-day moving average you would add up the closing prices from the past 10 days and then divide the result by 10. In Figure 1, the sum of the prices for the past 10 days (110) is divided by the number of days (10) to arrive at the 10-day average.
If a trader wishes to see a 50-day average instead, the same type of calculation would be made, but it would include the prices over the past 50 days. The resulting average below (11) takes into account the past 10 data points in order to give traders an idea of how an asset is priced relative to the past 10 days.
Here are the types of moving averages on the chart:
- Simple Moving Average (SMA)
- Exponential Moving Average (EMA)
- Smoothed Moving Average (SMMA)
- Linear Weighted Moving Average (LWMA)
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