Well, we will review again about the simple moving average trading strategy
In the previous chapter, we have started to recognize what is a moving average.
What does a simple moving average mean? Simple Moving Average (SMA) is one of the simplest types of Moving Averages indicators for trading.
Basically, the Simple Moving Average is calculated by adding up the last few closing prices.
Here we call the X period and then dividing the amount by X.
The result will be a moving average that changes over time, as long as prices are still raised by the market.
Maybe you are still a little confused with this explanation, well we will try to facilitate your understanding.
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Calculating simple moving average
If you use Simple Moving Average (SMA) period 5, then if you use a 1-hour timeframe the way to calculate is that you will add the closing price for the last 5 hours, and then divide the amount by 5.
Then you have an average closing price for the past five hours.
This formula is the same as the calculation of Moving Averages in general.
If you plot the Simple Moving Average with a period of 5 and select a timeframe on the 10-minute chart, then you will add the closing price of the last 50 minutes and then divide the amount by 5.
However, if you plot the Simple Moving Average with a period of 5 and choose a timeframe on the 30-minute chart, then you will add the closing price of the last 150 minutes and then divide the amount by 5.
Same way for calculations at higher timeframes, for example, 4 hours, daily or weekly.
On most trading platforms, it will automatically calculate Simple Moving Average with software making it easier for you as a trader, no need to calculating manually.
But even so, understand how to count Simple Moving Average is very important, so you will know how to edit these indicators according to your needs.
Understanding how to understand these indicators works, you can already set and create different strategies, and use them in trading included a simple moving average trading strategy
Simple Moving Average is not a perfect indicator
However, like many other forex indicators, moving averages operate with a delay.
Why is that? Because SMA picks averages from past price history, you really only look at the recent past general path and the general direction of “future” short-term price action.
Disclaimer: Simple Moving Average will not change you to get rich quick, this indicator also has weaknesses like most other indicators.
Example Simple Moving Average
Here is an example of how moving averages smooth price action in pair USD/CHF 1-hour timeframe.
In the image above, we attach three different simple moving averages (SMA) in the USD/CHF 1-hour pair chart.
As we can see, the longer the SMA period, the more it lags behind prices.
You can see how SMA 62 moves away from current prices, in contrast to SMA 30 and 5 which are closer to prices.
This is because SMA 62 adds to the closing price of the last 62 periods and divides it to 62.
The longer the period we use for SMA, the slower it reacts to price movements.
The SMA on the chart shows the overall sentiment of the market at the current time.
Now with using a simple moving average, we can get a conclusion that USD / CHF is trending.
Rather than looking at current market prices, moving averages give us a general view, and now we can estimate the direction of possible future price movements.
With the use of SMA, we can find out whether a pair is trending up, trending down, or just ranging.
But there is one problem with simple moving averages; they are vulnerable to spike.
When this happens, SMA can be giving a false signal.
We might think a new trend is forming but in reality, nothing is happening.
Weakness SMA Indicator
The simple moving average is a lagging indicator, to determine the position entry is often late to give a signal, however, you can combine with other indicators as a filter
By using SMA, we can know whether the pair is trending up, down, or just sideways.
However, there is one problem with the Simple Moving Average, which is vulnerable to surges.
If this condition occurred, usually a false signal will appear on the chart.
Thus, we can think that a new trend will soon appear, but in reality, nothing has changed. If you use the Simple Moving Average indicator on your trading system, you should use additional indicators such as the Oscillator to confirm the movement, so as not to get caught by fake signals.
How to use Simple Moving Average in trading
In general, there are three ways to do Open Position with Moving Average,
- Using SMA as a crossover,
- SMA with Price Action signals,
- SMA as a trend filter.
Below is an explanation for each function in a simple moving average trading strategy
Using SMA as a crossover
How to implement it, two SMA indicators are needed at once.
The commonly used periods are SMA-20 and SMA-50, SMA-20 and SMA-100, or SMA-50 and SMA-200.
How to determine entry when there is a death cross or golden cross on the SMA line.
If SMA-20 line crosses from top to bottom of SMA-50, this becomes a Downtrend signal, you can place a Sell position.
But if SMA-20 line crosses from the bottom up to SMA-50, then this is a sign of Uptrend, you can open a Buy position.
SMA with Price Action signals
Moving Average is also a dynamic Support or Resistance.
If the price moves across the SMA from top to bottom, then the SMA line will function as Support.
If the price is later closed bouncing off the SMA line, then this is a sign that the price will continue its bullish trend.
Conversely, if the price moves across the SMA from the bottom up, then the SMA functions as Resistance.
If then the price closes bouncing off the MA line, it will be a sign that the price will continue to its bearish trend.
To confirm the price pullback signal from the SMA as a dynamic Resistance Support, we can use the Japanese Candlestick pattern.
SMA as a trend filter.
In this case, SMA functions as a Trend filter.
If the price moves above the SMA line, then this indicates an uptrend.
Conversely, if the price moves below the SMA line, this indicates a downtrend.
To enable SMA as a trend filter, the period commonly used is SMA-200.
Then what about Open Position? You need one more indicator as a momentum confirmer for Entry. Indicators that can be used are CCI, Stochastic, or W% R.
If the Uptrend condition, which is marked by a price move above the 200 SMA, you can only make Buy positions. Wait for a Buy position when the CCI Indicator shows the price in Oversold conditions.
Conversely, if the downtrend, which is marked by the price moves below the 200 SMA, you can only sell short positions, waiting for CCI to be overbought.
The simple moving average trading strategy is actually a simple strategy, but you still need other indicators as confirmation signals when using SMA as a trend filter.
You can combine SMA with an oscillator indicator that functions to determine overbought and oversold areas.
But if you use two SMA by crossover trading, maybe the weakness is a late signal, you need more experience to determine the best entry.
And finally, that using all kinds of indicators included a simple moving average trading strategy you must be disciplined with entry point rules and also must use strict money management and good risk management.
Because not all traders in the world will use the same tool, there are actually many factors that determine the price changes in the forex market, reading news update world business might giving you new insight
Finally, it is still wise to use your funds to speculate in financial markets, for the next chapter we will review the exponential moving average.