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Why the 200-Day Moving Average Matters

In bull markets, the 200-day moving average is pretty useless. But during extended corrections like this one, it’s the most valuable indicator of all.

The most important trend-following tool for growth stock investors is the simple 50-day moving average. You should own growth stocks that are in uptrends above it, and you should welcome opportunities to buy when those stocks correct down to that 50-day moving average. (It’s usually best if that average is rising.)

The 200-day moving average, by contrast, is of little use for long stretches of time - like most of 2021. In long bull markets, stocks can trade well above their 200-day moving average for more than a year.

But in major corrections—and even bear markets—the 200-day moving average can be the most valuable moving average of all. That’s because just when all the news seems darkest—just when investors begin to feel that all is lost, as they have for the better part of a month now, and much longer than that for growth stock investors—the 200-day moving average pipes up and says, “Hey, this looks like a terrible time to sell; perhaps you should think about buying!”

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They say a picture is worth a thousand words, so let’s take a look at the following stock charts.

The 200-Day Moving Average, in Six Charts

The Dow Industrials

The Dow is now well below its 200-day moving average.

The S&P Midcap (MDY)

mdy-200.png

The S&P 600 (Small Cap)

The S&P 600 Small-Cap index is below its 200-day moving average.

The NYSE Composite

nyse-200.png

The S&P 500 (Large Caps)

The S&P 500 is now below its 200-day moving average.

The Nasdaq Composite (Growth Stocks)

nasdaq-200.png

So, that’s pretty definitive. All six of these major indexes are well below their 200-day moving averages, and basically have been since mid-January. Clearly, we are in a real market correction, with every index at least 10% off its highs. That’s the bad news. The good news is that most of the indexes have held above their late-January bottoms, with the exception of the Dow and the S&P 500, which didn’t dip as low as the other more growth-heavy indexes the first time around. If the other four indexes dip below their late-January lows, then this correction will likely last longer than some may have anticipated. If, however, those indexes hold above their previous lows, then perhaps it will be a sign that a meaningful bottom has already been put in.

Regardless, until any of those six indexes listed above can get back above their 200-day moving averages, it’s probably worth keeping new buys to a minimum and holding plenty of cash in your portfolio. Conversely, the 200-day line will tell you when it’s safe to buy again, because once the indexes get back above that line of demarcation, decades of technical analysis suggest that they’re likely to keep rising for quite some time. It probably won’t happen this week or even this month, but soon enough, it will happen, and a new rally will commence. And that’s where you’ll have a chance to make some real money.

Do you use the 200-moving average as a measuring stick in your investing? Or do you use other forms of technical analysis? Tell us about them in the comments below.

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Timothy Lutts is Chairman and Chief Investment Strategist of Cabot Wealth Network, leading a dedicated team of professionals who serve individual investors with high-quality investment advice based on time-tested Cabot systems.