After a dismal week for stocks, plagued by spiking bond yields, the S&P 500 Index closed within 1% of the 200-day moving average. Why is the 200-day moving average important, again? US stocks tend to go up when trading above their 200-day moving average and go down when trading below that threshold. What’s more, an extremely simple and cost-efficient trading strategy based on the 200-day moving average would have saved you from the bulk of major downturns and have realized a return more than double that of a buy-and-hold strategy in US equities.
The threshold between a rising and falling stock market
The chart below shows the average and median return on the S&P 500 Index on all trading days, on all days the index traded above its 200-day moving average, and on all days when it traded below that level since 1990. And the results are impressive. The average return on days the S&P 500 Index trades above its 200-day moving average equals 0.09%. To make that a bit more tangible, this translates into an annual return of +25%(!), assuming 260 trading days in a year. This compares to an average negative return on days the index trades below its 200-day moving average of -0.11%, or -25%(!) annualized. These averages are statistically significantly different from zero and each other. The differences for median returns are smaller but lead to the same conclusion.
But that’s not all. Since trading days above and below the 200-day moving average come in clusters, it also tells you where markets are going next.
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