Understanding the simple moving average in technical analysis

In technical analysis, the simple moving average (or SMA) is an average of the closing price of a stock over a specified number of periods. When the stock price changes, the moving average changes accordingly.

The above chart shows the moving averages for Apple’s (AAPL) stock.

For example, the stock’s five-day moving average is the average of the stock’s closing price for the last five days. As the moving average progresses, it drops the old data.

The moving average smooths the short-term fluctuations in the stock prices. It allows us to identify a clear market trend. When the stock price increases, the short-term moving average crosses over the long-term moving average. When the stock price decreases, the long-term moving average crosses over the short-term moving average. This crossover indicates the change in the price trends.

A simple moving average is also used as a stock’s support and resistance level. When a moving average is below the stock’s current market price, it can be used as a support level. When the moving average is above the stock’s current market price, it can be used as a resistance level.

The crossover of two moving averages—like five-day and ten-day moving averages—is used by some traders as entry and exit points. When the five-day SMA crosses over the ten-day SMA, it’s used as an entry signal. When the ten-day SMA crosses over the five-day SMA, it’s used as an exit signal in an uptrend and vice versa in a downtrend.

SMA concepts can be applied to stocks like Anadarko Petroleum (APC), Apache Corp. (APA), Conoco Phillips (COP), and Chevron Corp. (CVX). All of these companies are part of the Energy Select Sector SPDR ETF (XLE).

For more information on the companies mentioned above, visit the Market Realist Energy Commodities page.