TL;DR: Trend following with the 200-day average means going long when price closes above it and exiting when price closes below. The Golden Cross (50-day average crossing above the 200-day) and Death Cross (the reverse) are sometimes used as extra signals. The method works best in sustained trends and poorly in choppy, sideways markets.
What can you expect?
- Time per week
- Little: you check closing prices daily or weekly. Expect 30 minutes to 1 hour per week.
- Starting capital
- No fixed minimum. With small amounts, order costs per signal weigh heavily. With a fund or ETF you can also work with small amounts.
- Typical setbacks
- Several false signals in a row in a sideways market. You exit after a fall and price recovers immediately, or you enter just before a fall. Sometimes lagging buy-and-hold for years.
- Costs
- Order costs on every signal, spread, possibly currency costs on foreign markets, and fund costs for ETFs. Frequent trading can also have a tax effect. Compare costs between brokers.
- Not suitable if…
- Not for anyone who wants to trade every day or cannot sit through falls before a signal arrives. Not for anyone seeking certainty: a signal is not a guarantee.
How it works
The 200-day moving average (MA) is the average of the last 200 daily closing prices, about ten months. Many investors use it as a rough dividing line between an up- and downtrend. The strategy is simple: you are long while price closes above it, and you exit or stay out when price closes below. It is a lagging indicator, so you miss the start of a rise and exit only after price has already fallen. In sideways markets it often gives false signals that cost money.
Core principles
- 1. The 200-day average serves as a rough indication of trend
- 2. Stay long only while price closes above it
- 3. Exit on a close below
- 4. Use a confirmation rule to limit false signals
Step-by- step plan
- 1
Put the average on your chart
Add the 200-day simple moving average (SMA) to a daily chart. Optionally add the 50-day for crossover signals.
- 2
Determine the trend
Check whether price is above or below the average, since when, and whether the average is rising, flat or falling.
- 3
Fix your entry rule
Write down when you enter, for example after two closes above the average. Also set your maximum loss and position size.
- 4
Fix your exit rule
Decide in advance when you exit: a close below the average, with or without margin, or a trailing stop.
- 5
Track your false signals
Record how many signals lost money, including costs. Change your rule only on a long enough series, not after two bad trades.
In detail
What the 200-day average is
The 200-day average is the average of the last 200 closing prices. Each day the oldest price drops out and the newest enters. This produces a smooth line that filters daily noise. Many investors watch it, so it sometimes acts as support or resistance. That is not a law: the line is just an arithmetic average.
The number 200 is a convention. There is no proof that exactly 200 days is the best choice. Lines of 150 or 250 days look similar.
Golden Cross and Death Cross
A Golden Cross occurs when the 50-day average crosses above the 200-day. A Death Cross is the opposite. Both signals lag: by the time they appear, price has already moved a lot. They often make headlines but are not forecasts. Use them at most as extra confirmation, not as the sole reason to trade.
False signals and costs
In a sideways market price crosses the average again and again. You enter, get stopped out, enter again and lose a little each time. See the worked example below. Limit this with a confirmation rule (two or three closes), a margin (for example 2% below the average) or the monthly chart. Each measure makes the rule slower, so you lose something in one place that you gain in another.
Do not forget costs: every entry and exit costs order fees and spread, and a sale may create a tax effect. Check belastingdienst.nl for the rules that apply to you.
Test before you use it
Researchers and investors have tested similar rules on historical data, including in academic studies on tactical allocation. Results differ strongly by period, market and costs used, and a past test is no proof for the future. So test the rule yourself on your market with realistic costs, and try it first on a demo account.
- Basic chart reading
- Understanding of trends and risk management
- Charting platform with moving averages
- Current price data
- 01 Price closes above the 200-day average
- 02 Wait for confirmation: for example two or three closes above
- 03 The average itself is flat or rising
- 04 You have decided the maximum loss in advance (see risk management)
- 01 Price closes below the 200-day average (optionally with a margin, for example 2% below)
- 02 You can sell in stages, for example half on the first close below and the rest on the second
- 03 Alternative: a trailing stop at a fixed percentage below the highest price since entry
Worked example
This is a hypothetical example showing a series of false signals. It is not an expectation.
Suppose you invest €10,000 in an index and use the rule "buy above and sell below the 200-day average". For simplicity the index level is 100.
- Price closes above the average at 100. You buy for €10,000 (100 units).
- Price closes below the average at 96. You sell: 100 x 96 = €9,600 (loss €400, -4%).
- Price climbs back above the average at 99. You buy: €9,600 / 99 = 96.97 units.
- Price reverses and closes at 95 below the average. You sell: 96.97 x 95 = €9,212.12.
Total: €10,000 - €9,212.12 = €787.88 loss (-7.9%), before order costs and tax. Someone who held from 100 stood at -5% at 95. In a sideways market the rule can therefore cost more than doing nothing. In a long fall (for example from 100 to 60), exiting at 96 would have limited the loss to 4% instead of 40%. Which of the two happens, you do not know in advance.
Hypothetical example, not advice.
Work it out yourself
Risks and risk management
- False signals (whipsaws): in sideways markets price crosses back and forth, causing repeated small losses and costs
- Lag: the exit comes after a sizeable fall, the entry after a sizeable rise
- A sharp one-day fall can open far below the average so your loss exceeds plan
- Every signal costs order fees and spread and may have a tax effect
- Set the maximum loss per position before entry and size the position on it
- Use smaller positions in choppy markets
- Spread across several markets instead of relying on a single index
- Test the rule on historical data (backtest), including costs, before using it
Learn the basics
Key takeaways
- The 200-day average is a simple trend filter: it gives no price forecast and no guarantee.
- The rule lags price. That is its price: you miss the start of trends and exit after a decline.
- False signals are the main drawback. A confirmation rule, a margin or a monthly chart can reduce them but never remove them.
- Historical tests are sensitive to period, market and costs. Past results say nothing certain about the future.
Frequently asked questions
Does the 200-day average work on the AEX or European stocks? +
Technically the rule can be applied to any market, including the AEX. Whether it works depends on the period and the market. Test it with historical data and realistic costs. On foreign markets, watch currency risk.
How do I limit false signals in a sideways market? +
You can wait for two or three closes above or below the average, use a margin of a few percent, or look at a monthly chart. Each measure delays your signal. You can never remove false signals entirely.
What is the chance a signal makes a profit? +
It cannot be fixed. Results depend on market, period and costs. Promises of a win percentage are unreliable. Test it yourself as explained in the backtesting tutorial.
What software or broker do I need? +
Almost any charting platform shows a 200-day average. Choose a broker with suitable costs and compare order fees, spread and any currency costs. Use reliable closing prices.
Origin
General technique