A Long-term Investment Strategy with the 200-Day Moving Average
If you are looking for a way to be invested in the stock market during good times, but at the same time have some protection in place for when the next crisis hits, then look no further. Trend-following strategies should then be your friend, and I will here share a simple yet very effective such strategy designed for long-term capital growth with low volatility.
Aside from my crypto investments, I have long been looking for a low-maintenance investment strategy for the stock market. As I don’t have much time for short-term trading anymore, I am mainly looking to make long-term investments that I can simply buy and forget about.
However, I still want to be protected in case we hit another crisis or enter into a larger bear market. In my opinion, there are lots of risks on the horizon for the financial market. Still, a bull market is a bull market and any good trend-following investor should be invested in it regardless of his own feelings or opinions about where the market should be heading.
The 200-day moving average
The 200-day moving average is one of the most used technical indicators out there, and possibly the most popular moving average, particularly among US stock market investors.
Because of its popularity, as well as being featured in the media whenever the market crosses it, it works in many ways as a self-fulfilling prophecy. The 200-day moving average has also been in the headlines over the last few weeks after the plunge we saw in global stock markets in the beginning of February. The line then acted as support for the S&P, but a break below it would have been a significant event that many investors would take as the beginning of a larger bear market.
To illustrate this point, let’s take a look at the table below from Bloomberg. It shows six bear markets where losses exceed 20%, broken down by the loss before the market came down through the 200-day moving average and after it crossed the line.
The question now becomes if you can use the 200-day moving average as an indicator to follow in your own trading. You would buy when the market closes above the 200-day moving average and sell when it closes below.
The answer to that is that it definitely could be used to ensure you stay invested during prolonged bull markets, while avoiding deep corrections and market crashes. However, a problem with all trend-following strategies is what’s known as whipsaws – those times when the trend appears to start in one direction just as it turns again into the opposite direction. This is what kills the profitability of most trend-following trading systems.
Dealing with whipsaws
One strategy for overcoming the problem with whipsaws is to wait a certain number of days after the moving average line has been crossed before you enter your trade. This way, you would filter out a lot of the choppy price movements during times when the market is not showing any clear direction.
For example, one strategy that often is proposed is to buy only when the market has closed above the 200-day moving average line for 5 consecutive days. Similarly, you would sell when the market has closed below the same line for 5 consecutive days. 5 days seems to be a popular choice as it filters out most of the choppy price movements that are happening right around the moving average line.
Depending on what market you test this strategy on, you may find that the absolute returns would have been higher with a simple buy-and-hold system. However, pay attention to what happened during market crashes like the one we had in 2008. If you apply it to the SPY ETF (the ETF that tracks the S&P500), you will see that the strategy then went to cash and you would have been protected against further downside. In addition, keep in mind that nobody knows how deep the next crash will be, all we know is that sooner or later it will come.
Personally, I would rather sacrifice a little bit of my returns for an insurance against a completely unknown risk to the downside. In my view, this strategy is perfect for long-term capital growth while keeping volatility very low and giving peace of mind to the investor during times of market turmoil.
Featured image from Pixabay.