How do you know that a bear market has come to an end? In this article I'll take you through the 200 day moving average to show how it can be used to identify long-term trends.
When we look at trends in the market, the long-term trend is called the primary trend. Within this long-term trend, you can get smaller movements called the primary trend.
One way to identify the long-term trend or the primary trend is to use the 200 day moving average.
Like many indicators it is used to forecast where prices may be headed.
So let's start by taking a look at what a moving average is and how it can be used.
A moving average is a way to smooth out prices over time to help you identify trends. It's the average price over a period.
For example, a short-term moving average may use a 16 day average. This is the average price over 16 days.
A longer-term moving average may use a 200 day average which is the average price over 200 days.
You don't have to calculate the moving average yourself – you can find charts with moving averages on some websites. [Editor's note: Bell Direct will soon have new charting features in a couple of weeks and will include the moving average.]
The moving average works well when prices are trending strongly. They do not work well when share prices are moving sideways.
Here is the 200 day moving average from 2000-2009:
The black line is the S&P ASX 200 and the red line is the moving average (MA) line.
So the big question is how do you use the MA?
Moving average lines can act as support or resistance.
You can see that the red 200 day moving average line has acted like support or floor to share prices on the way up.
The S&P ASX 200 has had a difficult time getting below that red line. Once that red line was broken, the long-term uptrend broke and a new downtrend started.
That's where the red 200 day moving average line has acted like a ceiling to share prices on the way down.
It shows that share prices have had a difficult time breaking past that moving average. So the ASX 200 still hasn't managed to break the long-term downtrend, although it is getting close.
That's why many people in the market are still calling the recent rally a bear market rally. It's because it's a secondary uptrend within the longer-term downtrend. The long-term 200 day moving average still remains unbroken.
So that explains the 200 day moving average. The 200 day moving average in particular is significant because it is used by many traders to identify long-term trends.
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Happy trading!
Julia Lee Equities Analyst Bell Direct
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