Trend Indicators: Moving Averages (Simple)
Moving Averages or MA is a trend indicator that can be used to determine the existence and direction of a trend. This indicator becomes one of the most versatile tools that can be applied to price charts and is widely used as part of an automated trading system. Moving Average (MA) refines the motive of erratic price movements by averaging price data over a certain period. This can be the average of the closing price (close), opening price (open), high (high) or low (low).
The daily MA (5) of the closing price is the average of the closing price for the last 5 days. Since the MA calculates the average past (historical) data, the MA is referred to as a lagging indicator following the price movement. Thus, the MA identifies the trend only after they are formed. Furthermore, longer MA periods can be more seamless and less sensitive to price changes, compared to shorter MA periods with larger lags.
Type Moving Averages
There are four popular Moving Averages types: Simple Moving Average (SMA), Exponential Moving Average (EMA), Smoothed Moved Average (SMMA), and Linear Weighted Moving Average (LWMA). And there are also less popular Moving Averages, such as Triangular Moving Average (TMA), Variable Moving Average (VMA) and Volume Adjusted Moving Average (VAME).
Simple Moving Average (SMA)
Simple MA or simple is just an average of price data for periods analyzed with no extra weighting assigned to any data. Thus, the 5-day MA is calculated simply by counting the total price for the last 5 days and dividing the result by 5, by the following formula:
SMAn = (price1 + price2 + … + pricen) / n
where n is the high school period determined by the analyst or trader.
SMA has two weaknesses that can make it somewhat erratic. First, high school is very sensitive to falling prices (significant) when high school new rates are calculated. If prices are falling well above the average, it could cause the school to go down considerably and if prices fall well below the average, it could cause the SMA to increase considerably. Secondly, SMA is sensitive to the latest price added to the calculation. If the added price is well above the average, it can cause the SMA to increase substantially and if the added price is far below the average, it could cause the SMA to decline considerably.