200 Day Moving Averages (200DMA) Based Investments – 5 Years CAGR

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.
200 Day Moving Average Returns 5 Year
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.

  • 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.

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200 Day Moving Averages Based Investments – 3 Year CAGR

200 Day Moving Average (or 200DMA) is a popular ‘weapon’ found in every technical analyst’s or a trader’s toolbox. And surprisingly, it is one of the very few technical analysis tools that are easily understood by those who don’t respect technical analysis, i.e. even a fundamental analyst understands the importance of 200DMA


How To Calculate 200DMA

200DMA is calculated by taking arithmetic mean of all values in consideration (Stock prices, index levels) in last 200 trading sessions (40 weeks). 200DMA is generally used to assess long term trends. Another tool regularly used by traders to assess short term trends is 50DMA. Generally, a stock trading above its 200-day moving average is said to be in an uptrend and is being accumulated; one below it is in a downtrend and is being sold. (Learn how to calculate CAGR)

200DMA & 3 Year Returns

To find out whether there is a correlation between Investing based on 200DMA and returns obtained over a period of 3 years, I analysed Nifty’s data of last 20 years.

A comparison between 3 year CAGR and index’s distance from its 200DMA was made.

200 Day Moving Average 3 Year Returns
Correlation | Investing based on 200DMA & 3 Year Returns (CAGR)
The red portion indicates index’s level (+/-) from its 200DMA. For example, in region marked P, index was trading at level which was 20% lower than its 200DMA. The green portion indicates returns over a 3 year period on CAGR basis.

A few observations from above graph are –
  • Regions marked A, B, C, D & E had Nifty trading at level 20% (+) above its 200DMA. And as green graph shows, returns obtained in all 5 regions have been negative. As of now, discussion on region F is being left out intentionally.
Possible Reason: Chances of your investments earning a negative return are more if you invest at times when index is trading at a premium of 20% or more to its 200DMA.
  • In regions marked P, Q, R, S and T, Nifty has been trading at level 20% (-) below its 200DMA. And as green graph shows, returns obtained in all 5 regions have been positive.
Possible Reason: 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.
  • It is assumed here that investor is investing in index as a whole using an index fund or something similar. Similar graph drawn for individual stocks may show different results depending on sector’s business cycles.
  • Region F (i.e. Year 2000-2004) is an outlier in this analysis as during this period, India was in long term secular bull market and as evident from graph, relation between 3Y-CAGR and distance of index from its 200DMA is not evident. Returns continue to be positive even though distance from 200DMA oscillates between positive and negative.
This small but interesting analysis shows that though 200DMA is generally used by traders, it can be a handy tool in hands of a long term investor as well. On broad levels, it actually helps investors understand the general direction of overall markets. 

It is therefore advisable that one should always have a look at a stock’s 200DMA before investing in it.

You can read a similar analysis where 5 year returns were investigated for having a correlation with investments based on moving averages.

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