The Logic Behind Simple Moving Averages

Simple Moving Average (SMA) is among the most used arithmetic in technical analysis. The best forecast for the future price is the past prices.
This example will make you understand the logic behind the SMA.

Let's start with calculating the average for the series Y = {5, 7, 9, 2, 3, 8, 2, 4}. To calculate the mean for series Y, we need to sum up all the numbers in the series = (5 + 7 + 9 + 2 + 3 + 8 + 2 + 4) = 40. And then, divide this value by the number of elements in the series Y which is 8. So the average of the series Y is 40 / 8 = 5.

Now we can focus on applying SMA to the stock prices. Assume you have been watching "ABC" stock for ten days. The second column of the table shows you the cost of "ABC" stock in the last ten days. We will use the information to calculate Simpe Moving Average.

Days	ABC's Price
1	100
2	110
3	105

Let's assume you have been watching the price of "ABC" stock for three days. And when the market closes on the third day, you want to forecast tomorrow's / the fourth day's price. To do that, you take the average of the first three days' price: (100 + 110 + 105) / 3 = 105.

Now, you have to awaken up on the fourth day, followed by the "ABC" stock, and it ended up at 108, which is a little bit larger than what you had forecasted.

Days	ABC's Price	3-day-SMA
1	100	#NA
2	110	#NA
3	105	#NA
4	108	105

You have repeated the same approach for the following six days, and here are the results:

Days	ABC's Price	3-day-SMA
1	100	#NA
2	110	#NA
3	105	#NA
4	108	105
5	120	107.67
6	125	111
7	135	117.67
8	150	126.67
9	155	136.67
10	160	146.67

In Technical Analysis, the most popular MAs are 5-day, 20-day, 50-day and 200-day. Short-term traders buy when the 5-day MA becomes larger than the 20-day, and long-term traders buy when the 50-day MA become larger than 200-day MA.

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Thanks for reading, I will see you in anothor post!