Trading the 200-Day Is Effective, But Not Perfect

Using the 200-day moving average for trading is a good starting point, but you'll need to do more

Oct 26, 2015 at 9:38 AM
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Investing in stocks only when an index is above its 200-day moving average is about the simplest rule around. In the SPDR S&P 500 ETF Trust (SPY), for instance, it keeps you long something like two-thirds of the time, and would have captured almost the entirety of the gains since inception in 1993.

But it's also probably the slowest and most frustrating strategy around, if you're inclined to pay attention to your portfolio in any meaningful way. I bring this up because Friday marked SPY's first close above the 200-day since Aug. 19.

If you strictly adhered to the strategy, you would have gone all into cash on Aug. 20, at the end of a very ugly market day. SPY closed at $203.97, down 2.1%. As painful as selling into that felt that day, it sure looked good very quickly. All of two trading days later, SPY bottomed intraday at $182.40. Of course, that was really a bottom just on a quote, nothing anyone seems to have been able to actually buy. But even setting that aside, SPY closed at $189.50 that day.

And, of course, we revisited the lows a few weeks later. So, all in all, bailing out as the big number broke seemed like a wise idea. But alas, if you strictly adhered to the trade, you couldn't have bought anything until this past Friday. And, believe it or not, despite all the ugliness, the market is actually higher now than it was at the Aug. 20 close. In fact, it almost exactly made up the Aug. 20 loses in just over two months. Hard to believe.

I do have a couple thoughts here. One is that the principle is still sound -- albeit overly simplistic, of course. The idea is to try to side-step long-term bear moves. The cost here is very low. If in fact we're off to the races again, all you did was lose 1.5% in return for not being exposed to what could have morphed into a selling spiral. Psychologically, it hurts, but financially, not so much.

Two is that you should never trade/invest with hard-and-fast rules. It's great to have disciplines and all, but at the end of the day -- unless you're blindly trusting some sort of algorithm -- you need to make decisions on the spot. And there are just too many shades of grey around. The best course, IMHO, is scaling, doing partial positions, etc. If you have a mind to adjust the portfolio, do it in pieces. And by that I mean not all in the same day. Dollar cost average, stuff like that. You never catch the top or bottom in full; let the guys on TV pretend they can do that. You do tend to get a reasonable price, though most trends don't move in one direction forever.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research

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