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.
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.