200-Day Moving Average – Introduction
The 200-day moving average is considered the granddaddy of all moving averages.
Since there are just over 200 trading days in a given year, this moving average identifies the average yearly price in a market.
This is why traders and analysts alike use this tool!
In this article we will teach you what it is and how to apply it successfully to your analysis.
If you want to learn more about moving averages first, click here to read this article.
200-Day Moving Average – What’s the Big Deal?
The majority of retail swing and position traders actively track this average and place orders around this key level.
Trend followers and investors also benefit from using it!
Quite simply, it is the average closing price over the last 200 days.
Why is this so important?
Because it helps us track the longer-term trend of a financial instrument.
So when a market trades into it, you can be sure the financial media will be quick to make it a headline.
Speaking of which, check out this recent clipping of a Bloomberg article to this regard:
For the simple reason that so many market participants have eyes on it, track it, and execute around it. Price action tends to conform to the 200-day moving average quite nicely.
200-Day Moving Average – Signals
It is no secret that the price level which coincides with this average is seen as a major support or resistance on the daily chart.
This fact holds true in all markets, including equities, futures, Forex and commodities.
So how can we use it effectively in our analysis?
Well firstly, we can use the 200-day moving average to quickly determine the long-term trend in a market.
How to do this? Simply pull up a chart, plot the moving average and follow along below:
If price is above the average, the trend is bullish. If price is below it, that’s a bearish trend in play. Simple as that!
In the example below, we can see that the SP500 futures recently breached the 200-day moving average to the downside. After the initial breakdown, this market continues trading below it. From a technical point of view, there is a bearish trend currently in play in this market.
What this means to traders? Opportunities to play the short side. What does this mean for trend followers and investors? It might be time to lock in some profit or buy downside protection.
Rule of Thumb
A trend might not always be healthy just because a market is above or below the 200-day moving average. The further and further price travels away from the moving average, the more probable it becomes to see a reversion to the mean. Be warned! This extremely high reading of optimism or pessimism often leads to a sharp counter trend pullback. This will often precede consolidation within the trend. Check out the chart below to see a visual example of this.
200-Day Moving Average – Trade Signals
The 200-day moving average is such an attractive tool for longer term traders and investors because it usually forecasts macro price movements.
To this point, there are really only 2 signals that this tool will provide:
(1) A Breakout Signal
(2) A Bounce Signal
Let’s take a look at examples of both!
The Breakout Setup
When price breaks the 200-day moving average, it tends to continue in the direction of the breakout with massive momentum.
A bullish breakout above the average will often create a strong long signal. While a breakdown below the average will yield a strong short signal.
Just be sure to exercise patience with the breakouts! There are often false breakouts in the markets these days, so don’t get caught holding the bag at the top. A good tip when trading breakouts is to wait one more day. Let the bulls/bear prove they are in control and then enter on the high/low of the next candlestick.
You may pay a higher price for exercising patience. But this way, you’ll have more confidence in executing and managing the position. After all, if you get in during the early part of a new trend, a couple pips here or there will have little affect on your profits in the larger scheme of things.
The other tip when trading breakouts is to use volume as confirmation. A break above the 200-day moving average on low volume will often lead to a false breakout. The breakouts with the most follow through tend to have the most participation. Trade only the breakouts that have the volume to confirm that big money is participating.
Let’s take at some at examples of breakout setups below:
US Treasury Bond Futures
This market spent some time below the 200-day moving average before testing it as resistance in April 2014. Several failed breakout attempts lead to a tight consolidation range. We finally get an upside breakout over the moving average in the beginning of May. After this upside breakout, TBOND’s go on to rally over 35% for the next 2.5 years.
The bull run comes to an end when the market breaks back down below the 200-day moving average around October 2016. After this breakdown, the market declines by over 18% in a span of 2 years
GBP/USD Forex Pair
The Cable breached its 200-day moving average the first time in Sept 2015. After a period of sideways consolidation following the breakdown, this pair collapsed lower, losing 23% value or 3600 pips over the next year.
In October 2016, we saw a consolidation that led to a reversion of the mean. In late April 2017, this pair broke back above its 200-day moving average for the first time in almost 2 years. After a period of sideways consolidation, this market rallied over 12% for the next year. Increasing in value by 1600 pips from the breakout level. Finally, in May 2018 we had the most recent breakdown of the 200-day moving average. This breakdown has led to a collapse of nearly 8% or 1100 pips in the last 7 months and continues to show weakness for the foreseeable future.
It is not every day that the market breaks over or under its 200-day moving average. But when they do,the potential price movements make the wait worthwhile. We hope the examples have shown you the true potential of this setup and the vast profits that can be made by employing patience.
The Bounce Setup
This is probably our favorite way to enter a market as it offers the lowest risk and highest potential reward.
This type of setup generally has a better win-loss ratio than breakouts and allows for tighter stop loss placement.
When a market is trending, professional traders are not buying tops. They wait for pullbacks in order to locate low risk entries in the direction of the trend.
This makes up the foundation of the bounce setup!
Since the 200-day moving average captures the average yearly price in a market, it is a great level to find value within long-term trends.
To this point, when we see a market pullback and trade into the 200-day moving average, there is a usually a good chance that we will get a bounce off of this level. Of course, you will want to lean on other confluences (price patterns, candlesticks, order flow,etc) in order to qualify a trade. A good tip when trading bounce setups is to make sure price action respects the 200-day moving average in the past. When a market has previously respected the moving average, it is likely to do the same again next time it trades that level. The caveat here is the number of tests. It is only ideal to buy the first one or two pullbacks to the moving average during a trending phase. After two, it becomes a lot riskier and the risk usually outweighs the potential rewards.
Let’s take a look at some examples of bounce setups below:
In the above daily chart, we can see that Goldman Sachs was trading below its 200-day moving average for several months before breaking back above it in late August 2016. There were two valid short bounce setups before this breakout. After the breakout, the market tested it as support, which led to a massive run higher. At this point, the run was a bit overextended and a reversion to the mean was “due”.
After several weeks of consolidation,the market traded back into the 200-day moving average. It used it as support on several occasions before breaking to new highs. These were valid long bounce setups and offered great low risk entries to jump on the long train.
Once the market breaches the 200-day moving average to the downside, it trades lower. After some time trending lower, the market rotates back up to release some buy stops. This pullback brings the market back into the 200-day moving average, where it holds as resistance several times before price eventually collapses back in the direction of the breakdown. Again, these are valid short bounce setups that could have provided great opportunity to profit.
In the above chart, we can see Copper was trading below its 200-day moving average for the majority of 2015-2016. There were several pullbacks to the moving average during this time which offered valid resistance bounce setups.
Once the market broke above the 200-day moving average in late 2016, the bulls stepped in and drove the market higher. After posting a temporary pivot high, the market sold off back into the 200-day moving average, Offering an opportunity at a long support bounce setup. After a couple days trading near the moving average, the market went on to make new highs at $3.300. The market then tested the moving average another 3 times as support, offering valid bounce setup entries, before breaching it to the downside in mid-2018. As it stands, the trend is currently bearish in this market and we are currently scouting for short resistance bounce opportunities.
The 200-day moving average is a very important tool to include in your strategy.
This holds true especially if you are a swing/position trader or an investor.
We hope this article brought to light the benefits of tracking this key indicator!
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The information contained in this post is solely for educational purposes, and does not constitute investment advice. The risk of trading in securities markets can be substantial. You should carefully consider if engaging in such activity is suitable to your own financial situation. TRADEPRO Academy is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.