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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.
|Buy Above the 200-Day, Sell Below |
Only 28% of the trades in this test resulted in a positive outcome.
|Source: James Altucher|
Click here to see larger image. Test B: Buy the S&P when the close crosses the 200-day moving average, and sell one day later. The idea here is: Maybe people get so excited about the event of the crossing that they rush to buy. Result: Mildly positive, but not statistically significant and does not beat commissions and slippage. Of the 147 occurrences (not 142 like before?) since 1950, 74 were successful and 73 were unsuccessful, with an average return of 0.11% -- equivalent to 1 point in the S&P today. However, the results get a little better when you buy the 200-day crossover and hold for one month. Under these circumstances, you have a 72% success rate with an average gain of 1.65% as opposed to the 0.68% average monthly return since 1950. The last trade in this system started on April 17 and ended on May 16, for a gain of 5.68%. So perhaps it is bullish when the S&P 500 crosses its 200-day moving average and you hold for a month. Basically, you get double the return per trade of random buy-and-holding for a month. Holding for a quarter doesn't improve the results: You would get 2.67% per trade as opposed to an average quarterly return of 2.04% since 1950. Test C: What happens now if you run the "one-month" system described in test B on a basket of your favorite stocks? Buy a stock when it crosses its 200-day moving average, and sell one month later. I ran the test on the stocks in the S&P 400 mid-cap index over the past eight years. I ran it as a simulation where each trade took up 1% of equity and tabulated the results. Results were marginal: an average return of 0.62% per trade with the following yearly returns demonstrating that you would've survived the worst of the bear market but still taken a big hit in 2002.
|S&P 400 Mini-Cap Index |
Buying a stock when it crosses the 200-day and selling a month later offers marginal results.
|Source: James Altucher|
In general, although conceptually it does seem bullish when the indices cross their 200-day moving averages, it does not seem like there is a worthwhile trading strategy that results. Tests A, B and C bore little fruit.