A Primer on the 200-Day Moving Average

Editor's note: This column is a special holiday bonus for readers of TheStreet.com, written by James Altucher of Street Insight. To sign up for Street Insight, where you can read Altucher's commentary regularly, please click here.

Over the past month, the media have had a field day referring to the 200-day moving average. As in:

"The S&P index just crossed its 200-day moving average. This is a very bullish sign."

"Microsoft crossed its moving average, so we should expect to see a nice upwards move over the next week."

I was skeptical. It doesn't seem to make sense to me that this would be a bullish event. Most of the time when I read or hear about the 200-day moving average people are talking about the entry -- or the crossover of the average -- but never the exit, so it was hard to formulate a successful trading strategy.

Also, I was never sure what people meant by the word "bullish." Does this mean the market goes up forever now -- or just tomorrow?

To make sense of things, I decided to take a closer look at the 200-day moving average, what it signals and exactly how "bullish" it is. In general, my focus as an investor and hedge fund manager is to develop a hypothesis about the markets, whether based on fundamentals or price action, and test, test, then test again. No words of wisdom, or so-called 'truisms', about stock or indices are above being rigorously studied and verified as best one can before investing money.

I ran a few tests to get to the bottom of the 200-day moving average. I attempted to mirror and test the media prognosticators who forecast the change in trend with each move in the 200-day moving average. As you will see later on in this column, I came up with a long-only system -- in other words, it's only good for the long side of the market -- for using the 200-day moving average as a countertrend indicator that has worked well in both bull and bear markets.

But first things first: What is the 200-day moving average?