Simple Moving Averages (SMA)

It is very common for market data series to be smoothed, as smoothing reduces volatility, and allows traders to eliminate the bumpy movements. The two most common smoothing indicators are: Simple Moving Average (SMA) and Exponential Moving Average (EMA). As pointed out in Mak (2003), these smoothing indicators are actually low pass filters, which removes high frequency components and allows low frequency components to pass. As high frequency components are quite often considered to be noise, which is quite often difficult to trade with, and not very profitable, smoothing indicators perform the task of eliminating this noise before other indicators act on the smoothed data, so that buy sell indications can actually be identified. Smoothing indicators, unfortunately, are called trending indicators in the trading community, as traders claim the indicators can identify trends. That, of course, is a misnomer. As a matter of fact, velocity indicators, as described in the last chapter, are actually trending indicators. When velocity is positive, the trend is up. When velocity is negative, the trend is down. We will describe what smoothing indicators actually do in the following sections.