Does the 200-Day Moving Average Really Matter?

During last week's "flash crash," I received a panicked call from a colleague informing me that the Dow and S&P 500 had crossed below their 200-day moving averages. His comment was something along the lines of "Now we're really in trouble!"

My response, which was really more of a question and may have included a fair amount of sarcasm, was, "Really? That's what you're worried about at this point… a moving average?"

While I do pen a daily piece entitled "Technical Talk" I don't really consider myself a true market technician. You see, the real dyed in the wool techies don't care about why the market does anything. Nope, the battle cry among this group is "the tape tells all."

Personally, I consider myself more of a "market environmentalist" than a technician. You see, I do care (a lot!) about what drives the market and why things happen the way they do. And while I also spend a fair amount of time looking at charts (I never make a move without consulting the charts), I rarely venture past the "Technical Analysis For Dummies" stuff like moving averages, trendlines, support & resistance, stochastics, volume relationships, and maybe a Bollinger Band here and there.

It has been my experience that technical analysis (aka chart reading) works when it works and then is also absolutely useless at times. It is for this reason, that my primary goal is to stay in tune with what the market IS doing instead of trying to discern from the tea leaves, the phase of the moon, or the wiggles and giggles on a chart what the market SHOULD be doing.

But I digress. The question posed in the title of this big-picture missive is "Does the 200-day (moving average) REALLY matter?" Cutting to the chase, the answer is yes, it does – just not in the way the vast majority of investors probably think!

Like my panicked friend, who, given the plunge of 1,000 points that was occurring, had every right to be more than a little concerned on May 6th, I'd be willing to bet that the vast majority of investors – pros included – view an index crossing below its 200-day moving average as a negative. But, I'll let you in on a little secret; more often than not, this is actually a buy signal – as long as the moving average itself is moving upwards.

Yep, that's right; it is actually the direction in which the moving average is heading that is more important. For example, the computers at Ned Davis Research tell us that since 1946, there have been 64 cases in which the S&P 500 has crossed below its 200-day moving average when the MA was rising. But instead of the market going to heck in a hand basket as most investors would probably expect, two weeks later, the S&P has been higher by an average of +1.0%. The key point here is that this is actually BETTER than the buy-and-hold results for all 10-day periods of +0.5%.

One month later, the song remains the same.