Simple Moving Averages (SMAs): A Beginner's Guide

Moving averages are a continuously updated average, updated normally every day or unit of period. Simple moving averages are a common technical trading tool for investors and traders. Some of the basics of simple moving averages include the following: trending, support and resistance, average prices.

Trending

A moving average line can tell you whether or not the stock is in an uptrend or downtrend, you would need a short period moving average for this. A short period for simple moving averages could be a 5, 10, or even a 20 day moving average. This period would provide a trending line when used as a technical trading tool. When compared to the stock price, the short moving average can prove to be very insightful. The concept is very simple, when the moving average line is pointing up, the stock is in an uptrend. When the moving average line is pointing down, the stock is in a down trend.

Support

A longer period for simple moving averages could be a 40, 50 or 200 day moving average. This period would be helpful in finding an approximate price level for finding a support level. When compared to the underlying stock price the support moving average can become a very significant indicator for traders and investors. The support line is the level that should not be breached which is below the stock price. Theoretically, support is the level where demand meets supply, anything below the support level means that that there is an oversupply. If the moving average line is above the stock price that makes it a resistance level.

Resistance

The moving average line that is used to estimate the support level is also used to estimate the resistance level. The resistance line is the level that should not be breached unless a new trend is unraveling. After resistance has been broken, it is fair to say that there is a new bull cycle in the works. Theoretically, resistance is the level where supply exceeds demand, when it is broken demand exceeds supply.

Average Prices

Simple moving averages can also be used to find out the average prices that have been trading. Average prices pinpoint spots of congestion in trading that are normally revisited until a major event driven catalyst moves the stock price in a definite direction up or down. A very short period is used to define recent average prices that should be revisited. A very short period of one day or five days could be used as a technical gauge for this practice.

With all of these resourceful technical tools coming from one moving average indicator, it's no wonder why it is so important to learn about simple moving averages. Keep in mind, that you can use more than one moving average line at a time. This helps to gauge momentum as well as accomplish the aforementioned indicators using different moving average periods.