Simple Moving Averages Smooth Price Fluctuations
The simple moving average (SMA) is the average of a set of successive prices that smooths the routine ups and downs of a price series. The SMA, when plotted, eliminates the visual noise of daily price fluctuations found in the standard price and date chart. So the plot of a simple moving average identifies the general trend of prices somewhat more effectively than a plot of prices and dates. Therefore, some investors and traders use the simple moving average to help them determine if a change of price direction has occurred.
Example of 50-Day Moving Average
The chart for Hewlett-Packard (HPQ),
a diversified computer company, shows the closing daily prices and 50-day
simple moving average.
Notice that both moving average peaks after prices peak and bottoms after price bottom. Therefore, moving averages are called lagging indicators of price direction changes.
Computing the Simple Moving Average
To compute a simple moving average select a set of closing prices and the period over which you will compute the moving average. For example, assume you select of set of 300 successive daily closing prices and you want to compute the 50-day moving average for the 300 prices.
The first moving average is the sum of the prices for days 1 through 50 divided by 50. This value is associated with day 50 of the series. There are no moving average values for days 1 through 49.
Next, compute the average price for days 2 through 51 and associate this average with day 51. Next, compute the average price for days 3 through 52 and associate this average with day 52. Continue the averaging of successive 50-day prices until you compute the 50-day price for days 251 through 300, the last moving average in the set of 300 prices.
You may select any averaging period; popular moving averages are the 20-day, 50-day 100-day and 200-day.