One of the most popular technical tools used by traders is the Simple Moving Average (SMA). A moving average is commonly used to smooth out short-term fluctuations and highlight longer-term trends. In all cases a moving average lags behind the latest data point, simply from the nature of its smoothing. SMAs can tell you if the current price is above the average for x amount of days.
2 SMAs with different periods displayed on a candlestick chart
How can I calculate a SMA? You just add up a certain number of closing prices and divide the sum by that number. If you do that on a rolling basis, you will create a Simple Moving Average. You can use that average to generate BUY and SELL signals. See how!
The price crosses and closes above the SMA – a BUY signal
A BUY signal is generated when the price crosses and closes above the moving average.
The most useful way is to use at least two or three SMAs with different periods on the same chart. Traders usually prefer to use the 20, 50 and 200-day SMAs.
A BUY signal is generated when a shorter term SMA crosses above a longer term SMA. This is also called a golden cross. Lastly, you can actually look at the direction of the moving average. If it is pointing up, it will be considered bullish and if it turns down, it will be considered bearish.
A golden cross – BUY signal
The great thing about moving averages is that there is absolutely no argument for interpretation. This is because the price is either above or below the moving average. You cannot argue that. FOREX traders often use SMAs along with the Momentum indicator to determine when to buy or sell currency pairs.