The simple moving average (SMA) was one of the first technical indicators that many forex traders will come across. It is often the core foundation of a forex strategy as it can help traders to decide if they will go long (buy) or short (sell) in the market. The simplest use of an SMA in technical analysis is using it to quickly determine if an asset is in an uptrend or downtrend. Whilst you can use it on its own, I would always combine it with other technical indicators and price action analysis to time my entry in line with the overall trend of a particular currency pair.
What is the simple moving average?
The SMA is the easiest moving average to construct. It is simply the average price over the specified time period, usually 14-periods by default. The average is called “moving” because it is plotted on the chart bar by bar, forming a line that moves along the chart as the average value changes.
You can change the SMA period to something lower than 14 if you are looking for more signals. However, this usually means that you will get more false signals as there is not enough price data for the simple moving average to accurately determine the trend. On the other hand, you can always increase the SMA period to something larger if you are looking to try and catch long term market trends.
The simple moving average strategy can be used on any chart timeframe. If you are day trading then you might be looking at the 5-minute and 15-minute charts. I find the SMA signals to be less reliable on timeframes below the 1-hour. Even then, there will still be lots of false signals which is why it is important to combine the SMA with other indicators. I find that the daily and weekly charts tend to be the most reliable when using the SMA strategy, probably because they contain a lot more price data.
SMA vs EMA
The Exponential Moving Average (EMA) is similar to Simple Moving Average (SMA), measuring trend direction over a period of time. However, whereas SMA simply calculates an average of price data, EMA applies more weight to data that is more current.
The main advantage of the SMA is that it offers a smoothed line, which can be considered less prone to whipsawing up and down in response to small and temporary price swings. If you are not careful this can see you taken in and out of the market over and over again. The SMA’s main weakness is that it can be slower to respond to rapid price changes that often occur at market reversal points.
How to calculate the simple moving average?
The simple moving average is calculated by adding the price of a security over a period and then dividing that figure by the number of periods. For example, adding the closing prices of a security for the previous month and then dividing the total by the number of days in the month.
How to use the simple moving average?
One of the great things about the SMA is that it can be an excellent filter for any forex trading strategy. Whether you are using a stochastic crossover strategy, RSI reversal strategy or anything else, it can be ideal for deciding what direction you will be looking to trade in. Generally speaking, if price is above the SMA, we look for buy signals. If price is below the SMA, we look for sell signals.
There are also forex strategies which are based solely on the crossover of two or more simple moving averages, including the golden crossover strategy and death crossover strategy. Even if you plan on just trading with SMA’s and no other indicators, you should always be keeping on eye out for key price levels such as support and resistance. Looking for candlestick patterns can also be a good way to confirm any trades. I think there would be too many false signals if you were to use the SMA on its own without any other additional market analysis.
Buy signal
- Price is above SMA 14-period
- Price breaks through recent resistance level
- ADX (14) is showing an uptrend
- ADX (14) has momentum
- Bullish price action patterns
In the USD/JPY daily chart below, you can see that all of the above conditions for a buy trade have been met. We have price above the 14 SMA and it has broken through a significant resistance level. The ADX indicator is showing an uptrend because the +DI is above the -DI. The ADX is also above 20 which suggest we have some momentum in the upwards direction. The trade is confirmed with plenty of bullish price action including a three white soldiers candlestick pattern and large green bar. The stop loss could have been placed just below the 14 SMA which would have been around 70 pips. That’s not bad when you consider this uptrend continued for over 3,500 pips. There was ample opportunity to take profit along the way. Swing lows could have been used to move the stop loss into a winning position as the trend continued upwards.
Sell signal
- Price is below SMA 14-period
- Price breaks through recent support level
- ADX (14) is showing a downtrend
- ADX (14) has momentum
- Bearish price action patterns
In the EUR/USD daily chart below, you can see that price is below the 14 SMA and breached a strong support level that then became resistance. The ADX crossover showed that the -DI was above the +DI. The ADX was also above its 20 level which suggests this downwards move had some momentum. The entry was confirmed with bearish candlestick patterns including three black crows and a big red bar. We could have placed the stop loss just above the 14 SMA which would have been around 50 pips. That is quite low for the daily charts and gives a very favourable risk to reward ratio when you consider that this downtrend continued for over 2,100 pips. We could have used a trailing stop by moving the stop loss to recent swing highs on the way down. This could have helped prevent getting out too early and allow us to make the most out of the move.
SMA strategy Pros & Cons
Pros
- Catch some good market trends
- Enter in the direction of the trend
- Filter buy and sell signals with other indicators
- Can be used on any currency pair and chart timeframe
- Popular indicator so followed by many traders
- Free to use with customisable periods
Cons
- Can sometimes be lagging
- Requires additional confirmation
- Lots of false signals
- Need sensible money management
Conclusion: is the SMA forex strategy any good?
Yes, trading with the SMA may be an entry level forex strategy, but I think that trading with the trend can give anyone an edge. You just need to place the SMA on the charts of the currency pairs that you wish to trade and it will help you decide if you want to look for buy or sell signals.
However, you will need to time your entry and exit with other indicators and by studying price action. Not to mention, the results you see with any trading system are likely to depend on the money management that you use. I have seen the SMA strategy give a completely different set of results simply because of the stop loss and take profit levels used.
I like to try and cut bad trades short and let winning trades run. This way we can avoid one bad trade wiping out a run of consecutive winners. I might also move the stop loss to break even point at the earliest opportunity to lock in good trades and use a trailing stop to try and maximise each move.
If you would like to give the simple moving average strategy a try, you could always do so risk free on a demo account which you can get free from most forex brokers. This will enable you to practice how to trade with the SMA until you start seeing consistent results. You may then consider making the switch over to a real live account.
Self-confessed Forex Geek spending my days researching and testing everything forex related. I have many years of experience in the forex industry having reviewed thousands of forex robots, brokers, strategies, courses and more. I share my knowledge with you for free to help you learn more about the crazy world of forex trading! Read more about me.
