When it comes to learning the lingo about stocks, it literally pays to know what the different acronyms mean.
With so many chat sites and apps dedicated to discussion on the ups and downs of stocks, you can really learn a lot about when to buy and when to sell.
But you can only act on the tip-offs when you understand the terminology involved. Because how else will you be able to assess the level of risk or the potential of an opportunity or the extent of an issue?
That’s why it’s well worth reading articles like this one that explain the terminology and acronyms in basic, easy-to-understand terms, so you can arm yourself with knowledge that will ultimately make you more profitable in the long run.
The focus of this article is what SMA means in stock-speak. And as a bonus, we will also cover everything you need to know about the acronym, answering all your most frequently asked questions on the subject along the way.
Please feel free to scroll ahead to any section that jumps out at you. Here goes!
What Does SMA Mean In Stocks?
SMA Stands For Simple Moving Average
As you probably already know, even the most stable of stocks sees at least some movement on the stock exchange, and for this reason, it just makes more sense to talk about moving averages rather than just averages.
The SMA is a calculation of the average price of a stock either from a range of selected prices (usually closing prices) or over a specified period of time, or over a number of periods.
You work out the SMA by adding recent prices and then dividing that figure by the number of time periods in the calculation average.
The SMA is not defined as an average over a specific constant time period, but is instead customizable, and can be calculated over different numbers of time periods.
The time periods used to calculate the SMA influences both the volatility of the figure and how accurate the reading is. Short-term averages respond rapidly to short term fluctuations in stock prices, while long term averages are much slower to react.
The easiest way to envisage the SMA line on a stock price chart is to think back to science class when, after plotting all the data on the graph, you had to draw the best line to represent the overall trend of the data.
It smooths out the volatility of the data, making it much easier to view the price trend of a particular stock. And for this reason, investors use it as an indicator to let them know what will happen next in the stock price of an asset.
What Does The SMA Line Tell You?
Plotting the SMA line is a great way of charting the long-term trajectory of a stock price while ignoring the noise of day-to-day fluctuations. Traders can use it to compare medium and short term trends over a longer time horizon.
Many investors like to use the SMA value as an indicator of whether an asset price will continue as it had previously, or if it will decline, or if it will pick back up again.
And the results can be particularly telling if you plot more than one SMA line on the same chart.
For example, if you were to plot out a 50-day SMA, and a 200-day SMA, the 50-day value crosses below the 200-day one, this is what’s commonly referred to as a “death cross”, and it’s a sign that the stock price will see a decline, and predicts that further losses are in store.
On the other hand, if a short-term SMA breaks above a longer-term SMA, this is commonly known as a golden cross. And if this trend is further reinforced by high trading volumes, this can be a very positive sign, indicating that further gains will come about.
Is SMA A Good Indicator?
Let’s look at the pros and cons of using SMA values to predict stock price.
Benefits Of Using The SMA Line To Predict Stock Price
For investors who are looking to hold stock for a longer period of time, rather than going by day-to-day fluctuations, using the SMA can be invaluable. It makes trends easier to read, which in turn makes them easier to predict.
Investors can also take advantage of the customizability of the calculation (as described earlier) to either make it more responsive to fluctuations
Drawbacks Of Using The SMA Line To Predict Stock Price
It’s important to note at this point that the SMA is not the only indicator you can use to predict the movement of stock price. There are also other averages you can use, such as the EMA, which stands for exponential moving average.
And there are those who argue that other averages, like the EMA can be a more preferable technical indicator to use than SMA, or SMA alone, which leads us nicely onto our next section.
SMA Versus EMA
The SMA calculation gives equal weight to all the prices in the data, but the EMA is rather different. The EMA gives more weight to the more recent prices.
This makes the EMA value more reactive and timely. For this reason, the EMA value is usually the preferred indicator for many investors and trade analysts.
So, to reiterate, SMA stands for Simple Moving Average, and it’s a handy way to gauge how a stock prices varies over time, and is thus an easy way to try to make predictions about future stock prices.
Some traders like to make multiple calculations of SMA values, and use them to predict whether a stock price will go up or down.
But even then, this calculation is not without its limitations, and many trade analysts like to use alternative indicators, such as EMA (exponential moving average) which place a greater weight on more recent trends.
Either way, keeping an eye on stock price movements is valuable whatever metric you decide to use.
If you enjoyed this article, you might enjoy our post on ‘What Is A Bag Holder In Stocks?‘.