Like a new swear word sweeping across school playgrounds, suddenly everyone is talking about 200-day moving averages. The S&P 500 index is flirting with this crucial level, point out the pundits, having broken through it at the end of May for the first time in a year. That is a bullish signal, apparently. If the market drops below its 200-day moving average again, however, many reckon that is not so good.
Should investors beyond the inane chatter of the day-trading blogosphere care? Looking at moving averages is certainly a useful tool for smoothing out volatility and observing longer-term trends. That the 200-day moving averages for Russian and Brazilian equities are still falling in spite of their extraordinary bounce this year, for example, is a sobering reminder that this is still a bear market.
But history is one thing; having predictive power is quite another. From 1886 to 2007, buying and holding US stocks when the Dow Jones Industrial Average was above its 200-day moving average and selling them when the market fell below this level would have returned an annualised 8.6 per cent after costs, compared with 9.7 per cent for a buy and hold strategy, according to Jeremy Siegel, author of Stocks for the Long Run. That said, such a trading strategy would have avoided the 1929 meltdown while nicely capturing the subsequent upturn. Those watching 200-day moving averages would have also dodged the 1987 crash, although the practice has been pretty much useless since, completely messing up during the dotcom period.