Keep reading until the end, and you'll master this powerful indicator, learning how to avoid common mistakes and use it to your advantage in trading.
What is the Simple Moving Average (SMA) and How Does It Help You in Trading?
The Simple Moving Average (SMA) may sound like a complicated term, but it’s really just a tool that helps you see if the price of something, like Bitcoin, is generally going up 📈 or down 📉. Let’s break it down!
The SMA takes the average price over a set period (like days or weeks) and draws a smooth line on your chart. This line helps you understand the overall trend of the market without being distracted by short-term price changes. (By the way, you can adjust the settings to make this line more precise for your needs—I’ll explain how to do that in another article!)
In the picture above, the green line is the SMA for Bitcoin over the last 9 weeks. It shows the average closing price for Bitcoin each week. Since this is a weekly chart, the candles (the red and green bars) represent one week of price movement, and each candle closes at 12 a.m. UTC on Sunday.
Why Should You Care About This Line? 🤔
This green SMA line gives you a great way to figure out where the price might go next. Here’s how you can interpret it:
If the candles (the red and green bars) are above the green SMA line: This usually means the price is moving up, or the market is strong. You could think of this as a good sign! 👍 It’s like the market is showing strength and could continue to rise.
If the candles are below the green SMA line: This suggests the price is dropping, or the market is weakening. It’s like a caution signal, telling you to be careful because the price could continue to fall. ⚠️
But Wait! What About the Two Candles I See in the Chart? 🤔
If you’ve been watching the chart closely, you might have noticed two candles that look like they contradict each other. One candle might take the market up, while the very next candle takes the market down. This can be confusing and make you wonder, “Should I have bought when the green candle appeared? But now it’s red!”
This is a perfect example of what traders call false signals. A single candle closing above or below the SMA doesn’t always guarantee that the market will continue in that direction. Sometimes the market is indecisive, and it might show mixed signals before making a clearer move.
How Can You Avoid Being Misled by False Signals? 🚨
Here’s the key: Don’t rely on just one candle or a single crossing of the SMA to make your decision. There are two effective ways to avoid being misled:
Wait for Two Weeks of Confirmation 📅:
Since we’re using a weekly chart, each candle represents one week. If the price crosses the SMA and you see a red candle closing below the green line, wait for another week to confirm whether the trend will continue.
For example:
Week 1: The candle closes below the SMA (potential bearish signal).
Week 2: Another candle closes below the SMA, confirming the trend.
If you see two consecutive weeks of candles closing in the same direction (both above or both below the SMA), it’s a stronger signal that the market is heading in that direction. This helps avoid acting too quickly on a false signal.
Use Additional Indicators Alongside the SMA 📊:
Sometimes, the SMA alone isn’t enough to give you a clear picture. That’s why many traders combine it with other indicators, such as:
RSI (Relative Strength Index): This tells you if an asset is overbought (price may fall) or oversold (price may rise).
MACD (Moving Average Convergence Divergence): This indicator shows the relationship between two moving averages and can help confirm the strength of a trend.
By combining the SMA with these tools, you get a better sense of whether the market is really trending in one direction or just hovering indecisively around the SMA line.
What Happens if the Candle Closes Below the Green Line? 🚨
Imagine you’re watching Bitcoin, and at the end of the week (when the candle closes at 12 a.m. UTC on Sunday), the price closes below the green SMA line. This can be a signal that the price might keep dropping. It’s like the market is slowing down, and we could see the price fall even more in the coming weeks.
But, as mentioned earlier, don’t rush to make a decision just yet! Sometimes the price dips below the SMA temporarily and then goes back up. That’s why it’s important to either wait for another week of confirmation or use additional indicators to make sure the market is truly heading in a downward trend.
What's Coming Next? 🚀
In the next post, I’ll explain how to choose the right SMA settings for your needs. I’ll break down the difference between using a 9-period SMA, a 21-period SMA, or a 50-period SMA and why it matters. Plus, I’ll show you how to configure your SMA in TradingView so you can analyze trends with more precision. Stay tuned for more details! 👀
