The 200-period moving average (MA) is a long-term indicator used to determine whether an instrument is in a bear or bull trend. The 200-day MA is especially useful to long-term traders who want to hold on to their positions for weeks and months, but short-term traders also find the indicator helpful.
Here is a look at a few ways in which both long-term and short-term traders can use the 200-day MA to become more profitable.
Generating long-term buy and sell signals
The 200-day moving average typically generates a long-term buy signal when price crosses above it, and it generates a long-term sell signal when price crosses below it. The chart below shows an example of a buy signal generated by the 200-day moving average.
Chart 1: Buy signal generated by the 200-day MA
This example shows a buy signal that was generated by the 200-day MA on the EUR/GBP daily chart. However, there are other subtle lessons that we can learn from the chart. For example, it is clear that we would have given up a significant portion of our profit in September when the price fell.
The rule for trading based on any moving average line is that you only close trades when price crosses the MA line in the opposite direction. Most traders do not like giving up their profits, which is why the 200-day MA is typically used by long-term traders who do not mind giving up huge chunks of their profits as they anticipate more profits in future.
In the above scenario, many traders would have exited the trade as price started falling to secure their existing profits instead of watching as they lost two-thirds of their profits.
Focus mostly on trending markets
Another important aspect of trading based on the 200-day MA is to focus on trading assets that are trending as opposed to assets that are whipsawing, alternating between rallies and declines.
It is best to use other methods of technical analysis in markets that are not trending because you are likely to be more profitable compared to using the 200-day MA in such scenarios.
Chart 2: The 200-day MA in a trending market
The chart above shows the advantage of using the 200-day MA in a trending asset, which is the USD/CNY daily chart in this case.
You can see that the sell signals lead to a major decline and that traders do not have to give up a lot of their profits during pullbacks compared to the first chart. Most traders would have held their trades for the entire period that price was below the 200-day MA and would have closed their positions when price crossed above the MA line without giving up much of their profits.
How to enter trades midway through a trend
Another important aspect of trading the 200-day MA is choosing a trade entry point once the price has either crossed above or below the MA line and a new trend has begun. There are several ways to find high-probability trade entry positions in such cases, but the underlying principle is to focus on corrective structures and key levels.
Chart 3: Optional trade entry points using the 200-day MA
The Apple Inc. (AAPL) chart above shows three different key areas where traders had a chance to get into long trades on Apple stock after the price was already above the 200-day MA.
The first two entry points are at a support/resistance level, which is a key level, but it did not provide the best entry setup in this case as price fell shortly afterwards.
The second set of entry points provided the best risk-reward opportunities because they were pullbacks to the 200-day MA, which were followed by a strong continuation of the existing bullish trend.
The third trade setup occurred on a corrective structure where price pulled back in the form of a bearish trend, creating one last opportunity for traders to enter into a long trend and benefit from the final leg of the bullish trend.
The bottom line
The 200-period moving average is a dynamic indicator whose primary function is to define a bullish or bearish trend depending on whether the price is above or below this long-term indicator. There are specific conditions where the 200-day MA works perfectly, and there are situations where it does not work as well. You may find other opportunities to enter into trades based on the 200-day MA if you missed the initial signal, as shown above.