To conduct effective technical analysis of prices for any financial instrument, traders use graphical objects and technical indicators. While the former primarily answer the question of when to enter the market and fix profits or losses, the latter serve as a mathematical model of price behavior and can help identify patterns on charts. Even the simplest indicators possess these properties, which is why they have gained wide popularity. Among proponents of the latest technologies, such as neural networks, and fans of classical methods, heated debates continue regarding the accuracy and effectiveness of various indicators. For instance, investors try to determine if the 200-day moving average is effective in trading. Let’s try to answer this question.
From this article you will learn:
- The 200-day simple moving average (SMA) is widely regarded as a key indicator in stock market analysis due to its ability to filter market dynamics and highlight trends over long periods.
- While primarily utilized by investors with longer-term horizons, the SMA (200) serves as a valuable tool for identifying bullish or bearish trends based on its relative position to price charts.
- Combining the 200-day SMA with other moving averages, such as the 50-day SMA or exponential moving average (EMA), enhances trend analysis and provides powerful signals for traders, facilitating decision-making in the financial markets.
Briefly About Moving Averages
A moving average (MA), or simply moving, in trading on financial markets, is a continuous line plotted on the asset’s chart based on values of the selected price averaged over a specified number of bars/candles on the chart. This number, which is one of the main parameters of the MA, is called its averaging period or simply period. Two other important parameters are:
- The price whose averaging is performed. Typically, when setting up the moving in a trading terminal, the user can select characteristic prices of periods on the chart — opening, closing, maximum, minimum, and their derivatives.
- The method of averaging. Today, numerous averaging algorithms have been developed that reduce the delays of moving averages, improve their filtering ability, etc. However, most traders often choose two classic options: the simple moving average (SMA), which uses the simplest algorithm for calculating the average value, and the exponential moving average (EMA), in which the contribution of each period on the chart varies depending on its number according to an exponential law. This means that periods closer to the current moment in time are more significant than those further away.
Characteristics of movings are indicated directly in their designations. For example, when a trader sees the notation SMA (close, 200), they understand that it refers to a simple moving average built on closing prices of bars with an averaging period of 200. Similarly, EMA (close, 50) denotes an exponential MA with an averaging period of 50 bars, constructed on their closing prices.
Moving averages perform several main functions:
- Eliminate high-frequency fluctuations on the price chart. In fact, all movements with a period shorter than the averaging period are filtered out during averaging. In this sense, the moving average acts as a filter of market noise, allowing the identification of major trends in the market.
- Serve as a dynamic support/resistance line. Its intersection with the price chart can be considered as a signal of a change in the direction of quotes movement and possibly as a signal to enter the market.
200-Day Simple Moving Average
The most popular indicator in the stock market is considered to be the 200-day simple moving average — SMA (close, 200), built on the daily (1D) timeframe. Why has it gained such wide acceptance?
The main reason lies in its filtering properties. As mentioned earlier, the moving average filters out all movements with a period shorter than the averaging period. Thus, the 200-day MA filters market dynamics, highlighting trends with a period of 200 days or more. Why specifically 200 days? It’s quite simple — there are approximately that many trading days in a year on the stock exchange. In essence, this means that the 200-day moving average highlights the annual trend in the price movement of a financial instrument.
This indicator works well for investors operating on year-long horizons. Like other moving averages, it’s used to identify long-term trends. Its direction is indicated by the slope of the moving average, as well as its position relative to the price chart:
- If the price is above the MA — the trend is bullish.
- Otherwise — the trend is bearish.
When the price chart intersects with the moving average, a trend reversal or at least a sideways movement is expected. By the way, a slight slope of the moving average indicates a sideways trend.
Effectiveness of The 200-Day Moving Average in Trading
As mentioned earlier, the 200-day moving average can be an effective tool for those working on long-term horizons. However, even long-term investors typically use it only to determine the direction of trends. This is due to the significant lag of the MA with such an averaging period.
In fact, the SMA (200) itself and its relationship with the price chart are used exclusively as signals for buying or selling a particular asset. That is, if the average is moving upward and the price remains above this line, a trader or investor should look for opportunities to open long positions.
Some traders mindlessly memorize the thesis that the 200-day moving average effectively highlights long-term trends and therefore apply the same principle to other timeframes. But if the MA (200) has real significance on the daily chart because the averaging period is close to the number of trading days in a year, then on other timeframes, such a choice of period is practically useless.
The 200-day moving average is rarely used as the sole indicator. More often, it is used in tandem with another moving average — EMA (50) or SMA (50). It’s easy to guess that an MA with a averaging period four times smaller reflects trends developing over intervals four times smaller. The 200-day moving average shows annual trends, while the 50-day moving average shows quarterly trends.
In trading, the relative positions of both moving averages and the price chart are used. Now the direction of the trend is judged by the relative positioning of the MA lines — if the fast MA (50) is above the slow MA (200), it’s considered a bullish market, and if it’s below, it’s considered a bearish market.
In investments and trading, the crossing of SMA (200) with EMA (50) or SMA (50) is used as powerful signals. For a trader, they indicate a change in the existing trend and have even received their own names:
- EMA (50) crosses SMA (200) from top to bottom — “Death Cross.” Its appearance means that bullish trends will not return soon, and in the near future, one should prepare for a decline in asset prices.
- The opposite situation (MA (50) crosses MA(200) from bottom to top) is called the “Golden Cross” and indicates a probable rapid market growth.
Thus, the 200-day moving average can be effectively used only for long-term trading in financial markets. Typically, it’s applied to assess the overall situation and identify trends. Often, traders work with a pair of moving averages, with the second being the 50-day moving average. Their intersections — special points where a trend change occurs — are called the “Golden Cross” and the “Death Cross.