The many lines and symbols that interconnect and overlap on a stock chart can seem complex and difficult when viewed together, but if you see them as layers, the information conveyed is straightforward. Once you learn to separate the layers, you will begin to understand the simple fundamental data and numbers. You will in turn begin to see how these indicators can complement each other.
Two layers that can work together are the basic daily chart and the simple moving averages. The most recognizable even to beginners is the standard chart, which is a line based on the daily price changes of a stock. Sometimes called an alpine chart, it resembles a mountain range and is easy to translate to rising and falling prices. This chart records daily movement and it is influenced by many factors, including buying and selling, press releases and SEC filings. Since it reflects the short-term activity, it moves in a relatively sharp pattern. The more volatility a stock has, the more rugged or extreme this line will be.
Companies in the penny-stock and OTC market will display more volatility than larger established companies. It doesn’t require huge amounts of money to move a chart indicator when the price is less than $1, or even less in pennies. This will record all the daily activity, but an extreme chart like this will not give a very accurate view of any long-term potential performance.
Nothing can actually predict performance, but there are signs that indicate a trend, and that can be valuable. The next layer that shows this contains the simple moving average, a stock’s average closing price over a specific time period, which can refine and complement the daily chart. There are other types of moving averages, but starting with the simple moving ones will give you the foundation to expand your knowledge. They are less pronounced and move in larger sweeping curves. They can be adjusted to reflect different periods of time between price points and give an average indicator.
Simple moving averages reduce the appearance of volatility, one of the biggest problems of penny stocks and can give a better idea of the share price’s overall direction. It is helpful to look at them visually as patterns and not just try to translate everything into dollars and data because they are only averages.
The visual movement of the SMA lines can alert you to momentum. Momentum is an important indicator because it does not change overnight, either up or down. It tends to go beyond the present day and can be more important than sharp ups and downs if you are investing for the long term. Exactly how much the stock moves in a day may not be as important in the long run as seeing the trend.
A more interesting aspect is how they can complement the alpine chart. For example, you can track three different time periods, such as the 20-day, 50-day and 100-day. Most brokerage firms will allow the option to add and customize these on your daily chart. The smaller the time period, the closer they will track alongside the daily performance. They may move above or below it or even intersect at times, but where they track will indicate larger trends. In other words, you may be able to see if the company is slowly moving up or down. At times they could even contradict the daily chart, which could be moving in the opposite direction. But even a very volatile daily chart could still be slowly rising or falling overall and simple moving averages will show that.
If the SMA lines converge with the daily line, it could be a signal of a trend starting or changing. If either the daily or shortest moving average moves up, crossing a longer one, an upward trend could be starting, but it won’t be seen immediately in the longest one. The opposite could also be true if it moves down below a longer line, possibly indicating a downward trend. Neither mean the company is losing or gaining value over the long run, but it can be a signal to watch the longer trend.
This might indicate a good time to pick up more shares if the longer average continues to climb in spite of a daily drop below it. The daily could come back up to it.
It could likewise indicate a good time to sell shares if the daily rises temporarily up through the longer average which is moving down. This could mean the price will drop.
As with all the layers of a chart, no single one should dictate your financial decisions. A simple moving average will not accurately predict exactly where a share price will go, but it might give an idea of its general direction in the long term.