Moving averages aren't as mysterious as some technical analysts would have you believe. The moving average is, perhaps, one of the easiest and most popular tools available for anyone to use to determine trends. Once you master the moving average, you can use this tool to determine trends for anything from the stock market to the price of gasoline.

For instance, if you think in a straight line when it comes to time and space (like tomorrow happens tomorrow all over the world instead of in a black hole somewhere in an undetermined location), you have the 'moving' part of the "moving average" down. If you know how to determine an average, then you have the second half of that term figured out. Putting it all together might take a little work, but it's worth the effort when it comes to your money, right?

There are two types of moving averages that are used most often to determine trends in security prices: one is the Simple Moving Average, or the SMA; the second is the Exponential Moving Average, or the EMA. The SMA is the most obvious moving average, because it does, simply, calculate the average (mean) of a security over time. The SMA is the focus here, as you'll soon discover that it supplies the basics that you'll need for your long-term watch or consolidated portfolios.

While you could use the open, high, or low price to determine an average over time for the SMA, most moving averages in the SMA are computed from closing prices. For example, if a security closed at $35, $37, $40, $34, and $38 over a week's time, that security's mean for that week would be:

35 + 37 + 40 + 34 + 38 = 184; 184 / 5 (days) = 36.8

When you begin a moving average line on a chart, you would place a dot at $36.80, and that dot would represent the beginning of a moving average period.

To make that moving average line "move" in space over time, you would add the next day's closing price into the equation while you drop the first day at the same time. So the next computation would look like this if the next day's closing price equaled $33:

37 + 40 + 34 + 38 + 33 = 182; 182 / 5 (days) = 36.4

You would then place another dot at $36.40 and make draw a line between the first and second dot. You've now created the first leg in a moving average line over time.

At this point, you can go to Yahoo! Finance and open the historical prices for one of your watch or consolidated portfolio picks. Use the prices shown there to calculate an SMA for one or two weeks. If possible, draw the lines on tracing paper so that you can see the security's actual chart through that paper after you draw the moving average line, and use graph paper as a guide under the tracing paper as you draw the line. Once you've drawn a line for a week's time or more, you can see at a glance how the prices for your securities moved within that time frame.

Now, when you compare your smooth moving average lines to the jagged lines contained in that security's actual chart for that time frame, you can begin to see how a security might trade above or below a moving average line. In other words, at this point you might see how the smooth moving average line serves as an indicator for one of three trends: upward, downward, or sideways. An upward trend will illuminate higher highs and higher lows on the actual chart; a downward trend will be illustrated by lower highs and lower lows, and; a trend that moves sideways is one that moves for a period of time within a certain price range.

If you're still in Yahoo!, open your consolidated portfolio, the one that you built based upon the historical prices of two stocks that you wanted to watch over the past year. Click on the "edit" link located next to the word "Performance" in that portfolio so that you can add a moving average to your portfolio. Yahoo! offers choices between a 50-day or a 200-day moving average along with the ability to see any changes from either moving average. At this point you could benefit from adding a 200-day moving average and a change from that 200-day moving average (not the percentage), as that longer-term moving average would reflect your long-term goals.

When you add the 200-day moving average you'll see a dollar-cent figure (like 97.24) added to your chart. That figure represents the last point on the moving average line on the last trading day. But, unlike the five-day calculation you computed earlier, that last figure represents an average over 200 days. The change from that moving average will either be up or down, seldom the same number as the 200-day moving average number. This change figure (which will either be green or red for positive or negative change respectively) represents the difference between the 200-day final figure (which you see on the chart) and the first day of the 200-day period.

Watch how the numbers change at the end of each trading day over the upcoming week. Next week I'll explain the difference between the SMA and the EMA, and why the SMA is the better choice to use as a trend indicator for the long-term investor (other than its ease of use). I'll also explain when and where to use that SMA to your advantage as a long-term investor.

Until Then,
Linda Goin