The 200-DMA Is Within Sight

The stock market’s stall of the last few weeks has brought it closer to its 200-day moving average. Right now, it’s around 1,380 and we’re hovering about 2% above that.

The 200-DMA is an example of a dumb rule that has a surprisingly decent track record. Academics hate things like moving averages, and I agree that we shouldn’t place too much weight on their judgements, but they are worth watching.

What investors need to understand is that financial markets are biases towards trends. When something is going in motion, either up or down, it has a decent chance of continuing to go in that direction. Capturing the turning points is the tricky part and is best left alone. The 200-DMA is simple but it’s able to capture the stock market’s momentum.

Three years ago, I ran the numbers and this is what I found:

So does the 200DMA work? The evidence suggests that it’s a pretty good indicator of future price performance. When the S&P 500 has been below the 200DMA, it’s dropped a total of about 20% over the equivalent of 27 years. In other words, the S&P 500 has been below its 200DMA about one-third of the time.

Historically, the best time to invest has been when the S&P is less than 1.7% below the 200DMA.

When the index is above the 200DMA, well, then everything looks much brighter. All of the market’s gain and then some have happen when we’re above the 200DMA which occurs about two-thirds of the time.

The market seems to like nearly every point of being above the 200DMA. Danger only clicks in when the S&P 500 is over 17.5% above the 200DMA which is a very high reading.

Posted by on November 5th, 2012 at 10:18 am


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.