Macro Monday: Moving Averages (Simple)
All throughout my career as a stock analyst, I had been told that fundamental analysis is the only way to go since this is what most analysts rely on to make forecasts. Many new analysts today are never taught about technical analysis for this reason. However, I had a great professor in college who spent an entire week on technical analysis and its importance in portfolio management - and all the students tended to agree!
For beginners, the best approach to technical analysis is to take a look at moving averages - the 50-day and the 200-day. These two over the top of any stock's price chart can tell you a lot about the direction of the stock in the near future in terms of its overall health and when optimal buying and selling times will be. Below is a synopsis from Investopedia on the simple moving average...which is the best place to start.
Simple Moving Average (SMA)
A simple, or arithmetic, moving average is calculated by adding the closing price of the security for a number of time periods and then dividing this total by the number of time periods. Short-term averages respond quickly to changes in the price of the underlying, while long-term averages are slow to react.
In other words, this is the average stock price over a certain period of time. Keep in mind that equal weighting is given to each daily price. As shown in the chart above, many traders watch for short-term averages to cross above longer-term averages to signal the beginning of an uptrend. As shown by the blue arrows, short-term averages (e.g. 15-period SMA) act as levels of support when the price experiences a pullback. Support levels become stronger and more significant as the number of time periods used in the calculations increases.
Generally, when you hear the term "moving average", it is in reference to a simple moving average. This can be important, especially when comparing to an exponential moving average (EMA). We will discuss this one at another time.