Does a Long-Term Moving Average Indicator Predict Big Days?

A reader offered the following observation and question: “For many market observers, the 200-day moving average is the point of being in or out of the market. Does being above or below the 200-day moving average make a material difference with respect to missing the the best/worst 10, 20 or 100 days?” To check, we return to the data set for our blog entry of 12/03/07, which identifies the 40 biggest up days (daily return > 3.50%) and the 40 biggest down days (daily return < -3.09%) for the S&P 500 index during January 1950 through November 2007. Calculating the 200-day moving average (MA) at the close for each day just before these 80 biggest up/down days, we find that:

The following table organizes the 40 biggest up days and 40 biggest down days for the S&P 500 index since 1950 according to whether the index is above (left column with rows shaded light green) or below (right column with rows shaded pink) its 200-day MA at the prior day’s close. Note that:

There is not enough data to calculate the 200-day MA for the first two dates.

Of the 78 dates tested, 19 (24%) occur when the index is above its 200-day MA at the prior close. For these 19 instances, 4 are up days and 15 are down days, and the average return is -2.76%.

Of the 78 dates tested, 59 (76%) occur when the index is below its 200-day MA at the prior close. For these 59 instances, 36 are up days and 23 are down days, and the average return is +0.68%. This group includes 10/19/87, the worst of all days in the sample. Without 10/19/87, the average return for the remaining 58 instances is +1.04%.

It appears that a strategy of staying in (out of) the market while the S&P 500 index is above (below) its 200-day MA results in missing most of the extremely high volatility days, but it may not be good for net investing outcome. In this sample, the strategy catches just 10% of the big up days while missing only 57.5% of the big down days.

In summary, an investor who enters (exits) the market when the S&P 500 index crosses above (below) its 200-day moving average may miss most of the extremely high volatility days but will probably not enhance cumulative return by missing them.

More generally, results support a belief that extreme stock market volatility most often (but not always) follows substantial declines and sometimes signals market bottoms.

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