ARTIFICIAL INTELLIGENCE

“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