The 200-day Simple Moving Average or SMA is calculated by adding the closing prices of the previous 200 days, adding them together and then dividing by 200. That result is plotted on the chart and updated every day. These two charts below show this indicator, which is the green line on each chart. Many traders use this to help identify the direction of the trend. If the market is moving down and is below the 200-day SMA, then the trend is down. If the market is moving up and is above the 200-day SMA, then the trend is up. This is important for traders who want to increase their chance of success by trading with the trend. If the trend is up, then we only want to look for buying opportunities and if the trend is down, then we only want to look for selling opportunities.
We want to take advantage of the fact that in an uptrend, the moves up last longer than the moves down and in a downtrend, the moves down last longer than the moves up. This is part of what identifies a trend.
We also want to make more on our winning trades than we lose on our losing trades. This is what allows us the chance to be profitable if we can win half of our trades. Trading with the trend allows us the opportunity to do just that.
Ideally, we want to trade in the direction of the strongest trends we can find. The 200-day Simple Moving Average is one of the best tools we have to compare the strength of the trends, which is one of the main reasons it is so popular.
The DailyFX Trading Course offers a complete lesson just on the use of moving averages. Live clients have complete and free access to the material. If you are not yet a live FXCM client, email us at email@example.com and we can offer you a temporary login so you can see how we support our clients here at FXCM.