Using 200-day Moving average (MA) is a general standard of fund managers to identify bull or bear market, and this has eventually, became a standard indicator for many investors. Since it is an indicator viewed my many investors, it will form a "mass consensus effect", and therefore, it is an important indicator not to be ignored.
Generally, if a major index of a country (for example, the KLCI) breaks above the 200-day MA with substantial volume, then it is likely to enter a bull market. On the other hand, if the index should break below 200-day MA, it is likely to enter a bear market.
(Chart 1): KLCI chart from April 2006 to April 2009, with 200-day MA defining Bull or Bear market.
As shown on chart 1, the KLCI broke below the 200-day MA in March 2008, and entered a bear market (losing over 40%); until now, the KLCI still has not broken above the 200-day MA successfully. This suggests that the KLCI is still in bear market now. Nevertheless, the recently strong rebound of the KLCI has lifted the KLCI very closed to the 200-day MA, thus testing the bull market. If the KLCI should break above 200-day MA with substantial volume, it is likely that the KLCI would break away from the bear run and enter a bull market.
The Psychology behind 200-day Moving Average:
The formation of the 200-day MA is very simple, it takes up the closing price of 200 trading days, and divided them into 200. If we should round up 200 trading days, it is almost equaled to 1 year. Therefore, if a 200-day MA is moving lower, with the stock price staying below it, we could sum up that the long term trend is still bearish because the average movement of the stock price over a year is basically still falling, and therefore, a disciplined investor should not go against the trend, as the risk of buying during a downtrend is still higher. In contrary, if the stock price is rising while above the 200-day MA, it means that the stock price average for the year is generally rising, thus an uptrend, and therefore, buying investing during an uptrend is generally safer.
Examples:
(Chart 2) Genting [3182], from April 9, 2008 to April 14, 2009.
As shown on chart 2, price of Genting rebounded on the 18th of March, 2009, rising RM1.38 or 40%, but then, precisely resisted by the 200-day MA, and price started to retreat thereafter, which started a technical correction. This shows that the price trend of Genting is still in a long term downtrend, and the recent strong rebound is only a strong technical rebound. However, despite the resistance at 200-day MA, it does not mean that the rally is over. If price of Genting should break above 200-day MA with substantial volume, it is likely to break away from the long term downtrend and continue its rally, which is a new uptrend. This is why we mentioned Genting as technical rebound in last week's article, and stated that it is not forming an uptrend yet.
(Chart 3) Airasia [5099], from April 8, 2008 to April 14, 2009.
As indicated by A, price of Airasia tested the 200-day MA, but precisely resisted at it, thus suggesting the longer trend is still falling. As indicated by B, price of Airasia tested the 200-day MA again after 1 month, and still resisted by the 200-day MA. After being resisted by the 200-day MA, price of Airasia even marked a new low with a gap. As indicated by C, price of Airasia tested the 200-day MA again, but this time, successfully breaking above the 200-day MA, breaking away from the long term downtrend, and started an uptrend. (entering bullish trend). This is the effect of the 200-day MA break out not to be ignored, and therefore, we mentioned Airasia started an uptrend in last week's article, because its price broke above the 200-day MA successfully.
Practical Application of the 200-day MA:
Although we generally use a 200-day MA to define bull or bear market, it is usually too late to blindly follow the break out of break down of the 200-day MA. We must understand that a bull or bear market does not form overnight. All bull run started with a technical rebound, then forming higher-lows, and breaking new highs with substantial volume. Therefore, investors can start buying if the above 3 criteria (Higher-low, New Highs, and Strong volume) remain in place. In short, provided that the above three characteristics can sustain, an uptrend is likely to continue, and if price should break above the 200-day later, then only it can be confirmed as bull trend.
Conclusion:
If investors or traders could identify the characteristic of a reversal pattern (Higher-low, New-high and substantial volume), they can start buying even with the price below 200-day MA. If price should break above 200-day MA later, it would be a better signal for investors to hold on to their positions, as the breakout of the 200-day MA would create a mass consensus of a bullish market, thus a positive note to the market sentiment.
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