How to use the simple moving average indicator to time your trades

Thought Starters 5 minutes to read

Saxo Group

Summary:  The simple moving average (SMA) is an indicator that can help you time your trades and set limits to protect your drawdowns. SMAs provide a simple methodology for identifying support/resistance levels and entry/exit levels, and you can easily apply them to SaxoTraderGO's integrated charts.


What is the simple moving average? 
The simple moving average (SMA) is a technical indicator that represents the average price of an instrument over a specified period, such as 50 days or 200 days. This rolling arithmetic average line smooths out day-to-day price changes and you can use it to identify support/resistance and entry/exit levels on any asset class. 

The SMA is ‘simply’ calculated by taking the ‘average’ closing price for a chosen time period. For instance, the 20-day SMA is the average closing price of the past 20 days. The indicator is referred as ‘moving’ because the first data point rolls off as the next day is added. 

The optimal time period depends on your investment horizon. 200 and 100 days are commonly used for long-term trends, 50 days for mid-term trends and 10-20 days for short-term trading. 

Support/resistance 
You can use the SMA as resistance in a long-term downtrend and as support in a long-term uptrend. Therefore, you could place your stop-loss and take-profit using the SMA, putting your stop-loss just below the support/SMA in an upward trend or, alternatively, placing your take profit at the resistance/SMA in a downward trend. 

As illustrated in the chart below, the Apple stock reversed three times after running into SMA100 (resistance) before breaking out mid-March. Following the trend correction in early April, the SMA turned into the support that was tested four times without any breakthroughs until the end of June.

SMA1 larger 2
Support and resistance Apple, mid-Feb to mid-June 2020.

Crossovers (trading signals) 
Most investors use the SMA in their strategy to identify crossovers and thus their entry and exit points. A crossover can refer to 1) the price crossing the SMA or 2) an SMA crossing another SMA. 

A price crossover may imply a reversal of the price trend and thus a trade signal; a bearish signal if the price crosses through the SMA (support) downwards and a bullish signal if price breaks through the SMA (resistance) from below. The chart below shows that the Amazon stock crosses through the SMA100 at the beginning of September, which was indeed a bearish signal as the negative trend continued for several days. However, at the end of September, the price crosses again, which indicated the trend reversal.

SMA2 larger 2
Price crosses Amazon, begin-August to mid-October 2020.

As an alternative trading strategy, you could use multiple SMAs with different time periods. When a shorter SMA crosses above a longer SMA, it could signal that the trend is changing towards the upside, possibly indicating a good entry opportunity. Alternatively, a bearish trade signal could appear when the shorter SMA crosses below the longer SMA, indicating that the price may change direction, which could be a good time to sell/short. These crossovers are known as Golden Cross and Death Cross respectively and are mostly applied using the 50 and 200-day SMA. The chart below illustrates the price development of the SPY-ETF. The SMA50 crossed above the SMA200 at the beginning of July, which was followed by an upward trend. However, the SMA50 crosses below the SMA200 at the beginning of September, followed by a downward trend. Finally, we see another Golden Cross at the beginning of October.

SMA 3 larger
SMA crossovers SPY-ETF, end-June to mid-October 2020.

SMA disadvantages 
Be aware that the SMA indicator only uses historical data and does not account for fundamental changes in the instrument nor market developments. Moreover, the SMA indicator lags behind the price movement as it only appears after the fact. Hence, it's important to monitor the price development when the SMA is approaching the price or another SMA. The larger the time period, the larger the lag. Using a different kind of MA (WMA or EMA) reduces the lag to some extent. Finally, a choppy price development could generate multiple trade signals, meaning it’s sometimes better to just use another indicator. However, adjusting or enlarging the time frame could resolve this problem.  

How to apply SMA in SaxoTraderGO 
As shown below, you can insert the SMA indicator into your charts by selecting it from the indicator tab.

SMA4 larger
Apply the SMA indicator in SaxoTraderGO.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
Full disclaimer (https://www.home.saxo/legal/saxoselect-disclaimer/disclaimer)

Trade responsibly
All trading carries risk. Read more. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

This website can be accessed worldwide however the information on the website is related to Saxo Bank A/S and is not specific to any entity of Saxo Bank Group. All clients will directly engage with Saxo Bank A/S and all client agreements will be entered into with Saxo Bank A/S and thus governed by Danish Law.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.