A Primer on the 200-Day Moving Average

Simply put, it's the prices of a stock, or market index, the prior 200 days, added together and divided by 200. As can be seen in the following chart of the 200-day moving average -- the brown line -- most of the time when we are in a bull market, the closing daily price of the S&P is above the 200-day moving average. And most of the time when we are in a bear market, the closing price of the S&P 500 is below the 200-day moving average.

S&P 200-Day Moving Average The 200-day in relation to bull/bear markets.

The real question is, when the daily price of the S&P closes over the 200-day moving average, are we also moving from a bear period to a bull period?

To see if this trend-following assumption is true I ran three tests, labeled A, B and C. Here are the tests and results:

Test A: Buy the S&P when the close crosses over the 200-day moving average. Sell when the S&P crosses below the 200-day moving average. I felt this most closely mirrored what the media is forecasting when they mention this average.

Result: It's hard to qualify this as "bullish," but the results do yield positive returns. The winners are often huge wins and the losing trades are relatively tiny. However, only 28% of the occurrences of this system have resulted in a positive trade. In other words, if the S&P closes above its 200-day moving average, then there is a 72% chance it will be lower by the time it goes below its 200-day moving average. That said, doing this trade on every occurrence since 1950 would've made an investor money in the long haul:

Of the 142 occurrences since 1950: Forty successful, 102 unsuccessful, with an average return per trade of 3.23%, including the losses. If you put a $10,000 put into this system in 1950, it would be worth $55,000 today. If you put a $10,000 put into a buy-and-hold strategy, however, it would be worth $494,000.