Simple Moving Average (SMA)
Among all technical indicators present in the market, the SMA is by far the most popular and widely used. It is used when determining the direction of the market trend and can also be used in generating potential trade signals.
The simple moving average is a type of moving average that’s determined by combining the total of all closing prices on the market and then dividing the total by the number of days accounted for by the moving average. The simple moving average can create support and resistance for a given cryptocurrency.
What information does the SMA provide?
It is important to note that a simple moving average can be customized and calculated over varying trading periods. The simple moving average helps in smoothing out volatility and making it a bit easier for traders to study the price trends of any crypto asset that they are trading in. In a situation where the Simple Moving Average is pointing up, then that indicates that the price of the asset is also going up. On the other hand, if the Simple Moving Average is pointing down, then the price of that crypto asset is also going down. It is important to note that a more extended period moving average produces a smoother simple moving average.
Apart from being used to identify if a given crypto asset is in a downtrend or uptrend, two simple moving averages can be compared to determine the trend of the asset. This analysis is more complicated since you have to compare a pair of simple moving averages that are produced in different time frames. From the comparison, if you find out that the longer time frame’s simple moving average is lower than the shorter time frame’s simple moving average, then you should expect an uptrend in the market. On the other hand, if a short time frame’s simple moving average is below the longer-term simple moving average, then that signifies a possible downward trend.
Trading patterns that utilize the SMA
Two trading patterns make use of the simple moving averages, and they are the death cross trading pattern and the golden cross trading pattern.
A death cross trading pattern is observed when a 50-day SMA goes below the 200-day moving average. Such a scenario is considered to be a bearish signal that informs traders to expect further losses.
The golden cross is a trading pattern generated when the longer moving average is less than the shorter moving average. High trading volumes characterize this pattern and indicate an increase in expected gains for traders.
Limitations of the Simple Moving Average
One of the drawbacks of the SMA is that it relies too much on outdated data. Traders are not sure if they should focus more on recent trading days of the period. However, some traders believe that using new data will give a better reflection of the current trend of the asset. On the other hand, other traders believe that focusing on new data will bias the direction as past data is key in creating a reference for future prices.