This is the third article in our SMA series. If you haven’t already, we suggest that you check out the first article about the SMA Indicator. In the previous two articles, we have covered the background, the calculations involved, and how to use and read the “Simple Moving Average”, or “SMA”, indicator. The SMA was designed to smooth out the effects of price volatility and create a clearer picture of changing price trends. Traders use an SMA, sometimes in concert with another SMA for a different period, to signal confirmation of a change in price behavior.
The benefit of the SMA indicator is its visual simplicity. Traders can quickly assess the prevailing trend of price behavior from the direction of the SMA. Care must be taken since the SMA is a lagging indicator and may not adjust rapidly to volatility in the market. If shorter periods are chosen, then the lack pricing information can result in false signals being generated.
The following trading system is for educational purposes only. Technical analysis takes previous pricing behavior and attempts to forecast future prices, but, as we have all heard before, past results are no guarantee of future performance. With that disclaimer in mind, the “green” circles on the above chart illustrate optimal entry and exit points that can be discerned from using SMA analysis. Using the SMA in combination with another technical indicator is also always highly recommended.
A simple trading system would then be:
- Determine your entry point at the crossover when prices move upward through the lagging SMA line;
- Execute a “Buy” order for no more than 2% to 3% of your account;
- Place a stop-loss order at 20 “pips” below your entry point;
- Determine your exit point when the SMA crosses back through the pricing candles as they begin to reverse in a downward direction.
Steps “2” and “3” represent prudent risk and money management principles that should be employed. This simple trading system would have yielded a profitable trade of 90 “pips”, but do remember that the past is no guarantee for the future. However, consistency is your objective, and hopefully, over time, SMA technical analysis will provide you with an “edge”.
That concludes our series on the SMA Indicator. For further reading please visit our Forex indicators section.
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We also recommend you to read about the Aroon indicator.