This moving average has been in the limelight for the past few days. There have been comments and queries on it, so I will discuss this topic today.
How do you determine the trend? The answer to this question depends on the trader: Higher Highs/Higher Lows, falling/rising trendline, reversal patterns, MACD and so on. One way of determining the trend is to use the 200 day moving average to determine up and down markets. If the closing price is above the 200 DMA then the trend is up, if the closing price is below the 200 DMA then the trend is down. A 200 day average uses the past data of 200 days in its calculations, therefore it is not subject to short term movements.
Why 200? Well this represents about 10 months of price movement, therefore it should identify the primary trend of the market. There is nothing sacrosant about the number 200. Analysts found the 200 day easier to speak of, instead of referring to, say, 177 day average. Because it was a round number, as well as representing inermediate term price action, the 200 day become commonplace.
The 200 day average is of particular importance to position traders and investors. This group of people wish to stay as much as possible with the primary trend of the market. They are not keen to churn their portfolios. Now, the 200 DMA can remain below prices for months or even years, indicating a bullish environment, or vice versa.
When prices move below the 200 day MA, as they have done recently, they indicate that the uptrend is over. A break of the 200 DMA is not an event that takes place on and off. Now, the markets have a mind of their own. It is possible that the breach of the MA may just be a short term act, lasting only a few days. No one can predict the future. But, since we have to work with the present, investors will stay away from buying till prices remain below the MA.
What about the exponential 200 MA? Well, the only average that is popularly watched is the 200 days simple MA. So, this is the one that we should be interested in. You must have understood that 200 DMA is not some magic potion, it is relevant because a lot of investors watch it for trend direction. And, it does a reasonable task of catching primary trend movements.