**This moving average indicator is called “simple”, because it uses a simple way of averaging.**

Commander in Pips:Commander in Pips:

To estimate the value of a simple moving average (SMA) you need to do three things:

1. Specify number of trading periods that must be included in calculation;

2. Specify the price type of period – close, high, low or even (High+ Low+ Close)/3. As a rule Close price is used for calculation. The possibility for using of other prices types will depend on software, because not all software allows you to calculate SMA, say, for (High+ Low+ Close)/3. So, here we will talk about SMA on Close price;

3. Calculate simple average value of these numbers.

**???**

*Pipruit:***You need an example, do you?**

*Commander in Pips:***I would appreciate that…**

*Pipruit:***Ok, I’ll give you some, and you will help me. I suppose you can answer at least on points 1 and 2…**

*Commander in Pips:***No doubt, I can… So, I offer to calculate 50 period SMA and…**

*Pipruit:***Wait a minute - 50-period for a manual calculation is too much. Take a shorter period. The algorithm will be the same, but I will not have to post here huge tables with numbers. Think about your self – you will have to investigate all these tables, and…**

*Commander in Pips:***Ok, I’ve got it, I’ve got it. Let’s go with a 7-period SMA. And we will apply the close price for calculation.**

*Pipruit:***Ok, so be it. Now I show you how to calculate it. Take a look – this is daily EUR/USD chart:**

*Commander in Pips:*

*Chart#1 EUR/USD Daily*

By red numbers I’ve marked for you periods (in our case period is a day, because this is daily chart), which close prices take part in calculation of MA.

**I see, but why we count them from right to left, and not as usual – from left to right?**

*Pipruit:***I did it intentionally, because in the introduction to this chapter we said, that MA takes in consideration most recent number of periods. In our case they are most recent 7 periods. That’s why we count them in the opposite direction.**

*Commander in Pips:***I see. And why does our SMA have no value for most recent current bar?**

*Pipruit:***Because we’ve chosen Close price as a basis for calculation and the most recent bar has not closed yet. So, it couldn’t be used in calculation. But tomorrow, to calculate our MA value, we will replace candle “7” with current bar that will be closed already. That is how MA indicator “moves” across price action. But let’s move to the calculation – here are close prices for the 7 marked bars:**

*Commander in Pips:*Period N |
Close price |
---|---|

1 |
1.4185 |

2 |
1.4207 |

3 |
1.4137 |

4 |
1.3988 |

5 |
1.3882 |

6 |
1.3978 |

7 |
1.3973 |

Now, you should calculate the average price…

**Ok, we should sum all close prices and then divide this sum on the number of periods… Let’s see:**

*Pipruit:*(1.4185+1.4207+1.4137+1.3988+1.3882+1.3978+1.3973)/7 = 1.4050

Cool – that is precisely what software shows…

**Yes. Now let’s understand what it means that MA indicator is “moving” across price action. Let’s move one day back, and imagine the same situation for yesterday.**

*Commander in Pips:***Well, in this case, our bar #1 will not take part in calculation, because it has not been closed yesterday. And we should take into consideration the bar that stands before #7 on chart #1. So, it should look like this:**

*Pipruit:*

*Chart#2 EUR/USD Daily*

**Great work, you’re absolutely right. So let’s check it. Software shows (in table) value for MA as 1.4005…**

*Commander in Pips:***Yes, let’s see…**

*Pipruit:*Period N |
Close price |
---|---|

1 |
1.4207 |

2 |
1.4137 |

3 |
1.3988 |

4 |
1.3882 |

5 |
1.3978 |

6 |
1.3973 |

7 |
1.3869 |

(1.4207+1.4137+1.3988+1.3882+1.3978+1.3973+1.3869)/7 = 1.4005

Hold on… I think I’ve got it. It turns out that all the numbers remain the same, except just one – for 7th period. Oh, I understand what means “moving” – tomorrow software will replace 7th bar at chart #1 in calculation with the most recent bar, i.e. bar for current day, and so on… It’s a kind of drifting follow up to price action – candle chart with each candle shows the closing price of a single period, but the SMA shows the average close price for the 7 most recent periods instead of just the current close price.

And, is it possible to apply MA for other time frames? What will happen then?

**Of course it’s possible. In this case the software will continue to calculate the value of SMA, but will take as a close price not the daily close but the close price of the chart’s**

*Commander in Pips:***period, that you will choose**. For instance, if you will draw SMA on a 5-min chart, when each candle stands for a 5 minute period, thenthe SMA indicator will show you the average close for 7 past periods – i.e. 35 minutes. If you will apply it on an hourly chart- then for the 7 past hours and so on. If you hold the period number unchanged (7), of course.

I think that any software currently includes this indicator in technical analysis tool pack. But you have to know how it calculated, just to apply it in proper way, understand all its advantages and disadvantages and to be able to edit and tweak its parameters Also you need this knowledge for correct usage of this indicator in your overall potential trading strategy.

Now let’s point on some important moments of the MA Indicator.

- First, and the most important quality, that any MA is a lagging indicator, because it is based on past price action, although usually fairly recent prices;

- The longer the period of SMA the more “lazy” it is. This quality is derived from the math formula – it’s just how math works.

*Because, the higher number of periods in the calculation of any MA indicator – the smoother it is and less sensitive to recent price action. It is easy to understand. If we calculate a 3-period MA, then each period in calculation has a 33% impact on the overall value. Hence, when new period has appeared we can say that the value of MA renews for 33%. And now let’s consider a 50-period MA. Here each period in the calculation has only a 2% impact on the overall value of the Moving Average. And if market does not show real Doom & Gloom price action – even when new period has been completed, the value of 50-period MA will not change significantly, because 49 numbers in the calculation remain the same and only a single number has changed. So, the more periods in any MA calculation – the slower it reacts to price movement;*

- MA Indicator smooth market price action and shows us a general picture of the market’s sentiment and direction – whether it trending up, down or sideways;

- MA Indicator could be applied for trend estimation as a simplest one;

- One of the major qualities of a Simple MA is that it points equal weights to all periods in calculation, rather than give more weight to most recent periods and less weight to later periods. For example, if we calculate 10-period SMA and some crazy spike has happened 9 days ago – it will have the same weight in calculation and impact on overall value of the MA as the most recent close price.

*Pipruit:***And how to estimate trend direction with MA?**

**Well, you can apply different ways to do that, but I’m a fan of the simple approach. My slogan is to keep all things as simple as possible. I can apply sophisticated tools and strategies, but only when it is absolutely unavoidable. So, my approach is as follows:**

*Commander in Pips:***If market’s close price is above some SMA, then the trend is bullish. If it closes below some SMA – then the trend is bearish.**

**And what periods we should use for that?**

*Pipruit:***It’s impossible to answer on this question in a single way, because choosing a period for trend estimation is a very personal procedure and will depend on your trading style, preferred time frame for trading and other moments. You should estimate it for yourself, relying on your experience. But I will give you some numbers. Here are some well known numbers:**

*Commander in Pips:*- 50-period SMA is a very popular on the Stock market;

- 200-period SMA often applies on the Stock Market and Futures market as a long term trend indicator.

- You may use different numbers for different trends. For example, a 7-period SMA is for the short-term trend and a 25-period is for the long-term trend.

**Thank you. And how to treat such a situation, when the market shows a close below 7-period SMA, but above 25-period SMA?**

*Pipruit:***Then, it tells you, that short-term trend is down and long-term trend is up.**

*Commander in Pips:***And if the market closes above the 7-period SMA on an hourly chart, but below the 7-period SMA on daily time frame.**

*Pipruit:***Well, you’ve touched very important topic – how to combine different time frames in trading. We will talk about it in details in later chapters. But here the answer is – you will have up trend on the 4-hour time frame and a down trend on the daily time frame. Later you will understand that there is no contradiction here.**

*Commander in Pips:***And what if the close price is above SMA, but price of a current bar is below it?**

*Pipruit:***It tells us that confirmed trend is bullish, but the unconfirmed one is bearish. As you remember, we use close price above or below some pattern or indicator as a confirmation. But again – this is a question from another topic - how to ride the trend and how to trade it. Currently we speak purely about the nature of MAs…And trend estimation and trading we will cover in later chapters.**

*Commander in Pips:*
Is apari a viable FX broker?

Is my fund save trading with Alpari?

Thank you all and keep the good work strong.

Adebayo from Nigeria