The Importance of the 200 Day Moving Average

Did you know there’s a saying in technical analysis?

It goes a little something like this: ‘nothing good ever occurs when the market is under the 200 Daily Moving Average.’

Well, actually it’s not a common saying, but it tends to be quite true, specifically at a time when interest rates are high and increasing.

Let’s take a look at the SP500.

In white is the 200 Daily Moving Average.

Whenever price approaches the 200DMA, it’s important to look at any news events that are good or bad coming out at that time - not to do with specific companies, but more of a macro or geopolitical perspective.

Let’s get more granular and see what happened this week.

The SP500 had a run up through the 4000 point level.

Naturally this is a key psychological area (psychological levels aren’t specifically important in a market mechanics context, but they tend to be places where the likes of CNBC and Twitter accounts release info like ‘SP500 goes above 4000. Bull market back?’ etc.), but more importantly, the 200DMA is right above it!

The 200 DMA is important, simply for the fact it dominates passive trend following and is considered extremely effective. So ask yourself a question: should you try to compete with more complex strategies or play the game that large Commodity Trading Advisors play, which is trend following?

To get back to the central point, this week we had the issue with a missile landing in Poland which sparked some fear that there had been an infringement on a NATO ally’s land.

The market subsequently sold off.

There are two views you can take on this…

The news coincidentally occurred on the approach to the 200DMA or; The market was looking for a reason to sell off ANYWAY (it might have sold off on the heightened UK inflation number leading to a pull on global aggregate interest rates higher for example).

The fact of the matter is, we do not know what is coming, however if you are able to systemise your thoughts a little better, to pick up on little tells in the market and to realise the importance that larger players put on very simplistic methodologies, you can probably work towards accumulating a better edge.

Let’s take this thought experiment.

What do we know about interest rate regimes?

Well, increasing interest rates cause stocks to sell off (generally).

Lower interest rates cause stocks to increase (generally).

Let’s then look at the SP500 in a low/decreasing interest rate regime.

The chart is a little messy, but what we see is whenever interest rates are raised, the market sells off…

When they are stable and low (see from 2012ish), the market remains supported at the 200DMA.

I would hope this is creating a lightbulb moment for some, and reinforcing prior beliefs for other readers!