If a strategy, model, or indicator can’t even beat brain-dead buy and hold, then it doesn’t have much value [and that is the case with the 200 day moving average]. For every one time it does work, there are two times it doesn’t work. In other words, technical analysis gives you too many false signals that causes you to underperform buy and hold. Here’s proof.
The original article by Troy Bombardia has been edited here for length (…) and clarity ([ ]) by munKNEE.com to provide a fast & easy read
Many technicians regards the 200 day moving average as the “make it or break it” line. If the stock market is above its 200 day moving average, then it’s “bullish”. If the stock market is below its 200 day moving average, then it’s “bearish”.
The following chart is the S&P 500 right now. The S&P has been “saved” on its 200 daily moving average. Hence chart watchers would believe that the 200 daily moving average is useful.
Except when you look back at history, the 200 day moving average has more false signals than it has useful signals. The following chart demonstrates the 200 daily moving average’s many false SELL signals from 2014-2016.
Here’s the fact: there’s nothing special about the 200 day moving average…Traders use it solely because other traders are using it and, as we all know, doing something just because other people are doing it is generally not a good idea.
Here’s more proof that the 200 daily moving average (or any moving average for that matter) isn’t an extremely useful indicator.
- If you buy and hold the S&P 500 over the past 30 years (1988 – present), you would have earned an average annual return of 8.09%
- If you bought when the S&P was above its 200 dma and switched into cash when the S&P was below its 200 dma, you would have earned an average annual return of 6.56% over the past 30 years.
In other words, using the 200 dma to trade causes you to underperform buy and hold and, to top it off, traders face higher tax rates than long term investors so, after factoring in higher taxes, traders who use the 200 dma to trade MASSIVELY underperform buy and hold.
Some traders say “that’s why you should wait for the S&P to break below its 200 daily moving average for X number of days”. I’ve tried various combinations, and none of them improve the results from using the 200 dma…
Standard technical analysis gives TOO MANY false signals. That’s why you must combine technical analysis with fundamental analysis in your trading models/strategies…