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What is a Simple Moving Average?

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  • Written By: Alexis W.
  • Edited By: Heather Bailey
  • Last Modified Date: 09 November 2016
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The simple moving average, or SMA, is a financial metric used in investing in stocks. To calculate the simple moving average, it is important to first select a time period over which the average will be taken. The closing price of the stock on each day during that time period is then used to determine the average. For example, to calculate a five day simple moving average on a given stock that closed at $10.00 US Dollars (USD), $11.00 USD, $10.50 USD, $10.00 USD and $10.50 USD, it would be necessary to add 10+11+10.50+10+10.5 and divide by five because a five day period was used. The simple moving average in such a case would be equal to $10.40 USD.

Closing prices on a stock are the price that the stock is worth at the end of each given trading day. Markets are generally open from Monday to Friday during routine business hours. This means, for example, that the US market is open from 9:30 AM to 4:00 PM. Eastern Standard Time (EST) is used to determine the markets' opening and closing hours within the US.

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The price of the stock fluctuates throughout the day on the basis of how much buyers are willing to pay for a stock and how much sellers are willing to sell a stock for. The bid price, or the amount buyers are willing to buy for, is based on a number of factors relating to the perceived value of the company. The economy as a whole can also affect the market price of a given stock. Because the market price of a stock changes over the day, the SMA is calculated by the closing price in order to have a uniform time at which to compare the valuation of the stock.

Calculating the SMA is useful to determine and evaluate patterns for the stock. If the SMA is rising over a period of time, it can indicate an upward trend in the price of the stock, or a "bullish" or positive trend. When the stock moves above the simple moving average, this can also indicate a good buying opportunity because the stock is likely to be on an upswing. If the SMA is declining, on the other hand, this can indicate a "bearish" or negative trend.

The SMA can also be used to determine the resistance points of a stock. Resistance points are the points at which people usually begin to either buy the stock in the case of the "bottom" or the low resistance point or the point at which people decide the stock is not going higher and begin to sell. When a stock hits resistance, then it is a good indication that it will not go lower or higher. If it does break through resistance or "support" levels it can indicate a breakout, which means the price is likely to continue dramatically rising or falling.

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