Of all the types of moving averages, the simple moving average must be the simplest one, as its name suggests. The calculation goes like this:
- Add all the last closing prices of X period
- Once you get the sum, divide that by X
In simple moving averages, you are analyzing and observing the past prices to get an idea of how they behaved. You are also doing this because you want to know how the price will possibly act in the future.
Small moving average calculation explained further
Let us assume that you plotted a simple moving average with six periods on a one-hour chart. You need to get the sum total of all the closing prices for the last six hours. Later on, you need to divide the sum by six. Now, you have the average of the closing prices in the past six hours. If you string all of those average prices in one place, then you will get your moving average.
In another example, assuming that you plotted a simple moving average with six periods on a 30-minute chart. You want to add the sum total of all the closing prices for the last 180 minutes. Once you get the sum, you need to divide that by six to get the average closing prices.
This is a manual computation, but the charting software will most likely do all the calculations for you. However, extra knowledge will always be good, right? If you need to tweak the indicator, you will know how the software does the calculation and understand what is happening. Also, if you know how the indicator works, you can constantly adjust and adapt to different market environment changes. Also, it is not uncommon for forex indicators like the moving averages to have delays.
Let us cite an example for further understanding.
Let us say that we have a EUR/ USD one-hour chart with three different simple moving averages: 5, 30, and 60. If we look at the chart, the 60 SMA will be further from the current price compared to the 5 and 30 because we added 60 periods then divided that number by 60. Again, the longer the period used for the SMA, the slower its reaction to the price movement.
If we look at the chart where these three simple moving averages are plotted, we will also see the current and overall market sentiment. We will also see a pair that is trending. The moving averages give us a more expansive view compared to simply looking at the current market price. We can also have an idea of where the price will head in the future.
Is a simple moving average essential or relevant?
A simple moving average gives us the advantage of knowing whether the pair will trend up, down, or range even when prone to spikes. So, we should always be wary of false signals where things remain unchanged, but it looks like a new currency trend formed.