Knowing when to buy or sell a stock need not be tricky. Doing some simple math to calculate the 200-day moving average of a stock can help investors make better decisions.
The 200-day moving average calculates the simple average of the closing price of a stock over the most recent 200 trading sessions. The line drawn from those numbers shows the trend of a stock over a long duration. It is not meant for short-term or momentum trading.
A simple trading strategy would be to buy shares that are above their 200-day line and sell them when they dip below. IBD founder William O'Neil considered a drop below the 200-day average a late sell signal. Other sell signals will appear before the 200-day line is violated.
When the stock breaches the moving average in strong volume, that is a better indicator of a downward trend than if it dipped below in low volume. Also, if the dip is a small one, shares could reverse back above their 200-day line.
When holding leading stocks in particular, it may be worthwhile to wait and see if they reverse after a small dip below the 200-day line.
Some shares may actually fall below their 200-day line while building strong bases. Oil drilling company Halliburton started building a cup base in April 2022 (1) and broke out on June 8. The stock started weakening right away.
Halliburton made a decisive break of the 200-day moving average in early July (2). By then, the stock had triggered two earlier sell signals: It hit the 7%-8% sell rule and broke below the 50-day average about the same time (3). The stock has not recovered from the break of the 200-day line.
A Nuanced Reading The 200-Day Moving Average
A more attentive investor can put this indicator to even better use.
Sometimes a declining stock may find support along this line. If that happens, look for new bases and buy points. That's exactly what happened with Halliburton's October 2021-January 2022 base.
Biotech Amgen found support along this line twice in 2022: On May 2, shares rose 13% after finding support and again, on June 17, shares surged in strong volume from this support and gained as much as 10%. Amgen appears to be forming a base.
The 200-day line can also be a line of resistance for stocks. A stock's path is never linear and is filled with bases, breakouts and breakdowns. A stock often runs into resistance and finds support along the way as well.
On April 21 and Aug. 16 of 2022, the S&P 500 tested the line and fell both times. The 200-day will be a line of resistance for the broad index when it rebounds.
Market conditions also matter. When the market is in correction, a breakdown below the 200-day line is more likely to result in a further drawdown for even leadership stocks.
This article was originally published Oct. 13, 2022, and has been updated.
