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BabyPips.com > School > Elementary > Moving Averages > Simple Moving Average (SMA) Explained

Simple Moving Average (SMA)ExplainedA simple moving average (SMA) is the simplest type of moving average inforex analysis (DUH!). Basically, a simple moving average is calculated byadding up the last “X” period’s closing prices and then dividing that numberby X.

Confused???

Don’t worry, we’ll make it crystal clear.

Calculating the Simple Moving Average (SMA)

If you plotted a 5 period simple moving average on a 1-hour chart, youwould add up the closing prices for the last 5 hours, and then divide thatnumber by 5. Voila! You have the average closing price over the last fivehours! String those average prices together and you get a moving average!

If you were to plot a 5-period simple moving average on a 10-minutecurrency chart, you would add up the closing prices of the last 50 minutesand then divide that number by 5.

If you were to plot a 5 period simple moving average on a 30 minute chart,you would add up the closing prices of the last 150 minutes and then dividethat number by 5.

If you were to plot the 5 period simple moving average on the 4 hr. chart…Okay, okay, we know, we know. You get the picture!

Most charting packages will do all the calculations for you. The reason wejust bored you (yawn!) with a “how to” on calculating simple movingaverages is because it’s important to understand so that you know how toedit and tweak the indicator.

Understanding how an indicator works means you can adjust and createdifferent strategies as the market environment changes.

Now, as with almost any other forex indicator out there, moving averagesoperate with a delay. Because you are taking the averages of past pricehistory, you are really only seeing the general path of the recent past andthe general direction of “future” short term price action.

Disclaimer: Moving averages will not turn you into Ms. Cleo thepsychic!

Here is an example of how moving averages smooth out the price action.

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On chart above, we’ve plotted three different SMAs on the 1-hour chart ofUSD/CHF. As you can see, the longer the SMA period is, the more it lagsbehind the price.

Notice how the 62 SMA is farther away from the current price than the 30and 5 SMAs.

This is because the 62 SMA adds up the closing prices of the last 62 periodsand divides it by 62. The longer period you use for the SMA, the slower it isto react to the price movement.

The SMAs in this chart show you the overall sentiment of the market at thispoint in time. Here, we can see that the pair is trending.

Instead of just looking at the current price of the market, the movingaverages give us a broader view, and we can now gauge the generaldirection of its future price. With the use of SMAs, we can tell whether a pairis trending up, trending down, or just ranging.

There is one problem with the simple moving average: they are susceptibleto spikes. When this happens, this can give us false signals. We might thinkthat a new currency trend may be developing but in reality, nothingchanged.

In the next lesson, we will show you what we mean, and also introduce youto another type of moving average to avoid this problem.

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What Are Moving Averages?

Simple Moving Average (SMA) Explained

Exponential Moving Average (EMA) Explained

Simple vs. Exponential Moving Averages

How to Use Moving Averages to Find the Trend

How to Use Moving Average Crossovers to Enter Trades

How to Use Moving Averages as Dynamic Support and Resistance Levels

Summary: Using Moving Averages

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