Simple Moving Average

An explanation of a Simple Moving Average (SMA) according to stockcharts.com is an average formed by computing the average (mean) price of a security over a specified number of periods. While it is possible to create moving averages from the Open, the High, and the Low data points, most moving averages are created using the closing price. For example; a 5-day simple moving average is calculated by adding the closing prices for the last 5 days of trading and dividing the total by 5.
Day 1 = $10 closing price + Day 2 = $11 closing price + Day 3 = $12 closing price + Day 4 = $13 closing price + Day 5 = $14 closing price = 60
(60 / 5) = $12
The calculation is repeated for each price bar on the chart. The averages are then joined to form a smooth curving line -- the moving average line. Continuing our example, if the next closing price in the average is $15, then this new period would be added and the oldest day, which is $10, would be dropped. The new 5-day simple moving average would be calculated as follows:
Day 1 = $11 closing price + Day 2 = $12 closing price + Day 3 = $13 closing price + Day 4 = $14 closing price + Day 5 = $15 closing price = 65
(65 / 5) = $13
Over the last 2 days, the simple moving average moved from $12 to $13. As new days are added, the old days will be subtracted and the moving average will continue to move over time. The simplest way to use this information would be to buy shares of a company when the price crossed above its moving average, and to sell shares when the price fell below its moving average. Along with this strategy using more than one simple moving average at a time allows you to recognize momentum in a stocks trend in price. Using the chart below, when the (15 day) simple moving average crosses above the (50 day) simple moving average, that would be classified as a buy signal because short term momentum is outpacing the long term momentum, equating to more people being optimistic about the short term fundamentals and/or technicals of this company’s stock.