Why the 200-day Moving Average Matters

What does this very well known technical indicator mean for us as traders? At TradingMarkets we look at the 200-day MA as the cut-off in determining whether a stock or market is in a bull market or a bear market. We take long trades after we get a buy signal ONLY if the stock or market is above its 200-day MA. We take short positions after we get a sell signal ONLY if the stock or market is below its 200-day MA. So what is the big deal about this line that is drawn on our charts?

There are several technical indicators or patterns that point us to whether we are in a bull market or a bear market. Why is this moving average line on our charts the "line in the sand" in determining whether we are to be buying the market or selling the market? As with all of the trading strategies that we have come up with at TradingMarkets, we seek to find a behavioral pattern in the stock market, find the edge that it creates and then statistically quantify that edge. The behavioral pattern we see with the 200-day MA is quite simple. Literally everyone who is a market participant who looks at a chart of their favorite stock or market knows where the 200-day MA is on the chart. It is one of the most-watched of all technical indicators.

In my almost 20 years working on Wall Street for big brokerage firms, banks, investment banks, investment advisors, and hedge funds, the one indicator that everyone universally kept an eye on was the 200-day MA. Whether these participants were seasoned technical analysts, portfolio managers, traders, analysts, or inexperienced new traders or retail investors, the one technical indicator that they all watched was the 200-day MA. Even analysts and portfolio managers who only looked at fundamental research and didn’t believe at all in technical analysis would look at this one indicator. These portfolio managers and analysts that work for big mutual funds, pension plans and hedge funds represent the institutional money in the market, and they are considered the "big players" in the market place. As a general rule, these "big players" feel comfortable putting money to work in a stock or a market when they are trading above their 200-day MA. When the stock or market falls below the 200-day MA, they are less likely to put new money to work in that particular stock or market or to defend their position if the stock or market drops. So this is the behavior that occurs over and over again with almost all of the market participants and especially with the "big players" in the market who are in charge of deploying the enormous amount of money that people from around the world have invested in mutual funds, pension funds and hedge funds. So this is the behavioral pattern that creates an edge for us as traders.

In testing our trading strategies, we have statistically seen over and over again that a clear edge exists when a buy signal is triggered and the market is trading above its 200-day MA. Do these buy signals work if the market is below its 200-day MA? Yes they do, but there is a greater probability of success with a long trade when the market is trading above its 200-day MA. We have results that prove that there is a definite edge that exits in buying long signals when the market is above this moving average, or short trades when the market is below its 200-day MA. Remember, the big institutional players will put money to work in the market when it is above the 200-day MA and will step aside when it is below. We want to be trading on the same side or with the big institutional money. Again, this will greatly improve our probabilities of success and is the reason why every TradingMarkets trading strategy lists this as a qualifier or filter before you can consider it a true buy or sell signal.

Paul Sabo has been a professional trader for over 18 years. During this time he has worked as a market maker in both New York City and San Francisco for some of Wall Street's most prestigious investment banks, commercial banks and brokerage houses. Paul later became the head trader for a top-ranked investment advisor and hedge fund based in San Francisco. Paul recently left his position at the hedge fund to trade his own money as a full time business as well as working with Connors Research Group on various proprietary projects.

Learn more about the 200-day moving average in the "TradingMarkets S&P Market Timing Course". To listen to a free Market Timing presentation led by Paul Sabo and Larry Connors, click here.