In the previous post, I analyzed returns on investments based on 200DMA and how such investments performed over 3 year periods. This post is an extension of the thought with only change being the increase in evaluation period from 3 years to 5 years.
Just to remind everyone, 200DMA is calculated by taking the arithmetic mean of all values in consideration (Stock prices, index levels) in last 200 trading sessions (40 weeks). Before going forward, I would recommend that you get a basic understanding of how to calculate 200 Day Moving Average & how to calculate CAGR.
You can easily find data for last 20 years on NSE’s or BSE’s website. Similar to that in previous post, a comparison of 5 years compounded annual growth rate (5Y-CAGR) was made against the index’s distance from 200DMA.
|Correlation | Investing based on 200DMA & 5 Year Returns (CAGR)|
The blue portion indicates index’s level (+/-) from its 200DMA. For example, in region marked P, index was trading at levels 20% lower than its 200DMA.
The red portion indicates returns over a 5 year period on CAGR basis.
A few interesting results that can be seen from the graph are –
- In regions marked P, Q, R, S, & T, the index was trading 20% lower than its 200DMA. And as red graph in these regions indicates, returns have always been in positive territory.
Possible Deduction: Chances of your investments earning a positive return are more if you invest at times when index is trading at a discount of 20% or more to its 200DMA.
- Please note that it is assumed that investor is investing in index as a whole. A similar graph drawn for individual stocks may show different patterns and would depend on businesscycles of the sector.
- Region A (i.e. Year 2000-2004) is a possible outlier in this analysis. During this period, India was in long term secular bull market and as evident from the graph, relation between 5Y-CAGR and distance of index from its 200DMA is not evident. Returns continue to be positive even though Distance from 200DMA continuously switches between positive and negative territories.
This 5-Year analysis and a similar 3 year analysis done previously reveal that if an investor is ready to invest in markets trading at large discounts to their 200DMAs, probability of earning positive returns over long terms is quite high.
Though 200DMA is generally considered as a tool to be used by traders, it can very well be a potent tool in the hands of a long term investor who wants to time his entries in the market.