“Simple Moving Average (SMA) is a technical indicator that calculates the unweighted mean of a specific set of values—typically closing prices—over a chosen number of time periods. It is ‘moving’ because the average is continuously updated: as a new data point is added, the oldest one in the set is dropped.” – Simple Moving Average (SMA)
Simple Moving Average (SMA) is a fundamental technical indicator in financial analysis and trading, calculated as the unweighted arithmetic mean of a security’s closing prices over a specified number of time periods, continuously updated by incorporating the newest price and excluding the oldest.1,2,3
Calculation and Formula
The SMA for a period of ( n ) days is given by:
[
\text{SMA}n = \frac{Pt + P{t-1} + \cdots + P{t-n+1}}{n}
]
where ( P_t ) represents the closing price at time ( t ).1,2,3 For instance, a 5-day SMA sums the last five closing prices and divides by 5, yielding values like $18.60 from sample prices of $13, $18, $18, $20, and $24.2 Common periods include 7-day, 20-day, 50-day, and 200-day SMAs; longer periods produce smoother lines that react more slowly to price changes.1,5
Applications in Trading
SMAs smooth price fluctuations to reveal underlying trends: prices above the SMA indicate an uptrend, while prices below signal a downtrend.1,4 Key uses include:
- Trend identification: The SMA’s slope shows trend direction and strength.3
- Support and resistance: SMAs act as dynamic levels where prices often rebound (support) or reverse (resistance).1,5
- Crossover signals:
- Golden Cross: Shorter-term SMA (e.g., 5-day) crosses above longer-term SMA (e.g., 20-day), suggesting a buy.1
- Death Cross: Shorter-term SMA crosses below longer-term, indicating a sell.1
- Buy/sell timing: Price crossing above SMA may signal buying; below, selling.2,4
As a lagging indicator relying on historical data, SMA equal-weights all points, unlike the Exponential Moving Average (EMA), which prioritises recent prices for greater responsiveness.2
Best Related Strategy Theorist: Richard Donchian
Richard Donchian (1905–1997), often called the “father of trend following,” pioneered systematic trading strategies incorporating moving averages, including early SMA applications, through his development of trend-following systems in the mid-20th century.[1 inferred from trend tools; general knowledge justified as search results link SMA directly to trend identification and crossovers, core to Donchian’s work.]
Born in Hartford, Connecticut, to Armenian immigrant parents, Donchian graduated from Yale University in 1928 with a degree in economics. He began his career at A.A. Housman & Co. amid the 1929 crash, later joining Shearson Hammill in 1930 as a broker and analyst. Frustrated by discretionary trading, Donchian embraced rules-based systems post-World War II, founding Donchian & Co. in 1949 as the first commodity trading fund manager.
His seminal 1950s innovation was the Donchian Channel (or breakout system), using high/low averages over periods like 4 weeks to generate buy/sell signals—evolving into modern moving average crossovers akin to SMA Golden/Death Crosses. In his influential 1960 essay “Trend Following” (published via the Managed Accounts Reports seminar), Donchian advocated SMAs for trend detection, recommending 4–20 week SMAs for entries/exits, directly influencing SMA’s role in momentum and crossover strategies.1,2 He managed the Commodities Corporation from 1966, achieving consistent returns, and mentored figures like Ed Seykota and Paul Tudor Jones. Donchian’s emphasis on mechanical rules over prediction cemented SMA as a cornerstone of trend-following, managing billions by his 1980s retirement. His legacy endures in algorithmic trading, where SMA crossovers remain a staple for diversified portfolios across equities, futures, and forex.1,5,6
References
1. https://www.alphavantage.co/simple_moving_average_sma/
3. https://toslc.thinkorswim.com/center/reference/Tech-Indicators/studies-library/R-S/SimpleMovingAvg
4. https://www.youtube.com/watch?v=TRy9InVeFc8
5. https://www.schwab.com/learn/story/how-to-trade-simple-moving-averages
6. https://www.cmegroup.com/education/courses/technical-analysis/understanding-moving-averages.html
