Simple moving average

Our first example uses a 10-bar SMA, but technicians commonly use moving averages as long as 200 days (approximately one year in trading days) to define the long-term trend, as well as a combination of moving averages such as four-, nine-, and 21-day periods to simultaneously track three trends.

To calculate a 10-bar SMA, add the last 10 bars’ closes and divide by 10. When the next bar closes, the most distant closing price in the look-back period is dropped, the new bar’s closing value is added, and the new sum is divided by 10.

It shows simulated prices with a 10-bar SMA. (Notice it takes 10 closes to plot the first SMA value.) At point A, the simple moving average is near the middle of the price range. As price begins to rise, the simple moving average turns up a few closes later, illustrating the moving average’s inherent lag. The average continues to rise despite a short-term retracement (point B), and both values climb after that.

Next, price forms a double top and, as it declines, the simple moving average crests and turns down (point C). During the drop, the SMA trended down despite a final countertrend rise.

It shows the benefits and drawbacks of simple moving averages.

Despite short-term, counter-trend movements, the SMA filters out this noise and continues in the direction of the trend. But the SMA’s lag is noticeable when price changes direction.
It’s daily chart of the Euro/U.S. dollar currency pair shows the same characteristics. Here, the simple moving average follows the market as it peaks and then turns down (point A). The market retraces (point B), but the moving average continues to trend lower. At point C, price rallies above its moving average and the MA turns up. We see the same lag at points A and C when the market reverses the trend.