The 200-day moving average of prices is probably the most widely-watched indicator in the market.
Like many popular indicators – there’s nothing special about it – other than the fact that it’s so widely-watched. Its popularity gives it something of a self-fulfilling prophecy effect.
Still, the beauty of the indicator is its simplicity. Without attempting to make bold predictions, the 200-day moving average simply answers the question: “Is the stock more expensive or less expensive than it has been, on average, over the last year or so?”
It’s a layman investor’s question and a layman-style answer.
It also creates an agreed-upon line in the sand. If a stock’s price is above the average, most investors get bullish. If it’s below, the market gets bearish.
Even better, any basic financial software worth its price (even if free) has the ability to scan through a long list of stocks, sorting them based on whether they’re above or below the average. So market participants with a bearish bias can quickly find the stocks that are already trading “below average.”
The 200-day moving average is also useful in determining where a fight will break out. Here’s what I mean…
Support and resistance levels occur when buyers and sellers are equally matched. Think of it like a game of tug-o-war. If both sides have the same number of pullers and they’re all equally strong, the rope doesn’t move. The same thing happens at support and resistance levels. And the 200-day moving average usually acts as this tug-o-war battle ground.
Here’s a chart of the Japanese yen. It’s actually a chart of YCS, an inverse ETF of the yen (so when the yen’s value drops, YCS goes higher).
You can see three major “battles” occurred around the 200-day moving average this year.
In the first, which I’ve circled in yellow, the yen was strengthening (YCS falling) into summer. Then, upon hitting the 200-day moving average, YCS just traded sideways from mid-May through mid-July as buyers and sellers fought it out.
In the second battle, highlighted by the red circle, YCS attempted another rally after falling below the 200-day moving average in late July. This rally was quickly halted once prices ran back up to the 200-day moving average, which acted as strong resistance.
And in the third battle (green circle) YCS rallied again this fall, running up to the 200-day moving average by late October. Bulls and bears played tug-o-war for a month, with YCS hopping over and under the 200-day moving average, before buyers eventually won, sending YCS much higher.
This should show how important it is to keep an eye on the 200-day moving average, especially when current market prices are approaching. There’s no way to predict which direction prices will go once they hit the 200-day moving average, but you can bet on a fight breaking out – and often a significant turning point taking place.
If you haven’t done so already read the Survive & Prosper issue on “Five Things Small Business Owners MUST Do.”
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