Greetings Traders, and welcome back to another In Depth with Chris episode.
In today's discussion, we'll be talking about the smoothed moving average.
This is, in fact, a technical analysis based indicator,
so those of you that are my TA based traders, well, you've
got a treat in store for you today.
This is something that we hope will help you get closer to
your goal of passing the Gauntlet Mini, or at the very least,
help you progress farther in your trading career.
Now without further ado, let's go ahead and work our way
through those disclaimers.
That way we can get onto the juicy information that follows.
While we're doing that, if you haven't already, please
click that like and subscribe button down below so I can
keep coming out with content for all of you out there. Now let's get going.
As part of being a proactive trader, it's important for us
to constantly be aware of the various tools that are
at our disposal should we so choose. That way,
we know how to handle any situation that comes our way, at least in theory.
As we scour the internet looking for new tools or things
that we haven't yet covered or used, one thing we might come
across is this smoothed moving average.
We'll start off with what the smoothed moving average is at first.
I bet you can't say that 5 times fast, at least I can't.
The smoothed moving average is quite simply a moving average
that assigns weight to price data points over a long period.
The point here is that traders are going to use this
to gauge market trends according to a series of averages over a given period.
As the data becomes more available, they'll recalculate the
averages to accommodate the newer periods.
This is why we call it a moving average, because it is
constantly accommodating newer periods.
We can think of the SMMA, which is the smoothed moving average,
as a hybrid of its better-known siblings, the simple moving average
and the exponential moving average, otherwise known
as the SMA and the EMA.
The SMA looks at the price of a traded asset, and it divides
it by the given period to be studied, but it looks at all periods equally.
Now, unlike the EMA, the EMA is going to place more emphasis on recent data,
as we've discussed in the past. The smoothed moving average
provides a broader view of things than both of these
by smoothing out, so to speak, the short term market fluctuations.
This added accuracy helps traders confirm market trends quicker
and hopefully more reliably.
This chart that we're looking at shows Microsoft and we have
on it both an SMMA, which is the green line,
we have an EMA, which is the red line, and we have an SMA
or simple moving average, which is the blue line.
We can see how, over the course of the same period of
measurement, how these lines did not follow the same exact
trajectory, even though it was relatively similar.
Here we have the calculation for how the smoothed moving average
comes to be. Now this isn't something that you'll need to memorize,
as most platforms are already doing this math for you as it
plots the indicator in front of your very eyes.
But just for the sake of completeness, I wanted to make sure
we included this problem so you are aware of exactly how it is,
if you're interested. But for the rest of us, let's keep moving.
The smoothed moving average is an indicator that plays
a vital role in many trading strategies.
It is in fact a lagging indicator, which means it's great
for confirming prevailing trends.
This leads us into three of the most common trading strategy categories
that smoothed moving averages seem to fall into.
The first is the trend following category.
This is when the trader buys an asset whose price is already
on the rise and confirm to be trending upwards in the trend
because of the smoothed moving average. They can also short
the asset when the price is already falling and confirm to
the downside with the smoothed moving average.
The beauty with this strategy lies in its relative simplicity.
It's not only common sense to buy an asset that is rising
and common sense to sell an asset that is falling.
The smoothed moving average line itself can serve as a guide on when to buy.
We can look at the steepness of the line and how long that
line has actually been in play for as our justification for
getting in when we are using it as a trend following type
of strategy with the smoothed moving average. Then we have
the reversal side, and the reversal is a little bit trickier
and generally not for the faint of heart.
It can provide massive opportunity when it's done correctly,
but it is much harder in most people's eyes to do correctly.
The way reversals with smoothed smoothing averages are found
is generally with a moving average cross.
Instead of using just one line, traders will look to use
a couple of lines across different periods and pay attention
to when the short line moves underneath the lower line and
look at this as an opportunity to potentially sell as the
short-term momentum is falling below the previous existing
longer-term momentum, or the other way around.
When the shorter moving average looks to move above
the longer-term line, they can look at this as an opportunity to buy.
Then we have the current price concept that goes in conjunction
with using SMMAs, and this is really something that can
help us if we're just starting our trading day and looking
for some great entry points and we're trying to make a more
informed choice. If the asset's current price is trending above
the SMMA line, that can be a signal to buy. When it goes down
below the SMMA line, then we can look to exit the position.
The reverse is the case when we're looking to short. We would
sell when the current price goes below the SMMA line,
and we would look to exit that position
then when price therefore rises back above the SMMA line.
Relatively simple concept to make sure we're on the right
side of things with the help of the SMMA.
It's important to understand how the smoothed moving average, the SMMA,
compares to this simple moving average, so we don't ever really confuse
the two or use them exactly as we would use the others.
The most significant difference between the smoothed moving average
and the SMA is that the time frame involved with calculating
the SMA is usually quite a lot shorter.
An SMA uses the shorter period to calculate the average,
and one of the drawbacks with this is that the short-term
trend line does create for a possibility of false signals.
If we use a longer-term trend line that can provide a stronger
signal, but in return, we usually now have a lag.
Traders also have to wait until the price action is confirmed
before making their moves in the market, and in doing so,
they might miss out on some prime trading opportunities when the trend began.
The smoothed moving average helps avoid this issue by covering
an extended period of time, thereby removing that short-term
fluctuation bias. Then because it's smoothed out, traders
can easily view the trend with a little bit more confidence.
Then we have the smoothed moving average, when it's compared
to the exponential moving average, which we refer to as the EMA
The EMA is an advanced form of an SMA, and it can help
traders confirm the prevailing market trend a little bit
faster because of that added weighting factor on more recent
prices. However, the sensitivity to recent volatility can
also be the main drawback to an EMA.
For example, if the market experiences a sudden spike,
the EMA line will reflect that change.
Suppose the trader is not using another indicator to confirm
the trend and the strength behind it.
In that case, they could take action based on the fall signal
generated by the short term volatility and get themselves involved in a mess.
The smooth moving average, however, helps prevent this because
it is also considering past data generating that average,
and instead of emphasizing on more recent data, it enables
a more accurate and relevant average that is not easily swayed
by short-term volatility.
In conclusion, the smoothed moving average is an indicator
that can provide some very valuable insight into what's going
on in the market, as well as provide opportunities to enter
using a variety of strategies like we discussed.
As far as what the smoothed moving average is not so good at,
it does provide a rather myopic view of the information that's on your screen.
It provides a smoothed average over what's going on, but
it's not providing ulterior views, which is why the smoothed moving average
is often used in conjunction with things like
the Bollinger Bands, the Stochastic Oscillator, as well as
a variety of other technical indicators to further confirm
what's going on in the market in a more fine point manner.
But until next time, thank you for joining me
as always folks. Please make sure you click that like and
subscribe button down below so I can keep coming out with
content for you all out there.
Until then, good luck in the markets out there.
Stay safe. I'll see you soon.