How Good Is the 200-Day Moving Average

Here’s a project I was working on this afternoon. I took the data for the S&P 500 going back to 1928 (technically, it wasn’t 500 stocks until 1957). I then divided it into days when the S&P 500 was above its 200-day moving average and days when it was below.

Here’s the chart. The blue is above and the orange is below.

For being such a simple rule, the 200-DMA isn’t bad. When the index has been below its 200-DMA, the market hasn’t gone anywhere. After 92 years, it has lost more than half of its value. For the last 80 years, the S&P 500 has basically been net flat when it’s been below its 200-DMA.

The index has been above its 200-DMA about two-thirds of the time and below it one-third of the time.

Why has the 200-DMA been relatively effective? My hunch is that it plays into a key aspect of the stock market. The stock market moves in trends. A rising market will tend to keep rising, and a falling market will tend to keep falling. The downs are usually more severe. The turning points are the hard part.

The 200-DMA plays off the market’s momentum. It cuts you out of a plunging market even though it will do so after the peak. On the other side, it will get back into the market after the bottom. It locks you into the trend but misses the turning points by a bit. The benefits of the former is more than enough to make up for costs of the latter.

Did it work this year? Here’s a look at the S&P 500 and its 200-DMA:

Posted by on December 1st, 2020 at 4:13 pm


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