A Primer on the 200-Day Moving Average

One More Try

I decided to try one more approach. A contrarian one that depends on the concept of mean reversion -- i.e., when the price of the S&P hits an extreme low relative to its 200-day moving average, one should buy. Specifically:

Buy when the S&P closes 20% below its 200-day moving average (e.g., the crash of 1987 or on Sept. 20, 2001) and sell one month (20 trading days) later. Very simple.

Result: Since 1950, if you made this trade in all 79 occurrences, 65 of which were profitable (82%) and 14 unprofitable (17%), for an average return of 6.43% per trade as opposed to a return of 0.68% if one randomly buys any month. Not bad.

It gets even better when you measure more recent history. If you look at the data for the S&P 500 index since 1975, this system would've resulted in 34 out of 34 successful trades with an average return of 10% per trade. The last trade started on Oct. 10, 2002, ended on Nov. 7, 2002 -- and returned a nice 12.28%. That's enough to pay the bills and have a nice glass of wine to celebrate.

Arguing about the trend of the market based on the 200-day moving average might be fun at cocktail parties (depending on your definition of fun) but won't really make anyone money. Instead, buying when the trend is absolutely, unequivocally down and the market is plummeting vis a vis its 200-day moving average is usually the best time to take a trade on the long side. By the time the talking heads are debating a new trend when price closes above the 200-day moving average you are long gone out of the market, hopefully on vacation.