When you write a blog that has readers from all over, it is sometimes a challenge to decide how you need to pitch a topic. On one hand you can assume that your readers know most of the things you are referring to and just get on with the blog post. On the other you may have to explain the basic details elaborately, before getting on with the main topic. I have referred to 200 DMA as a basic indicator for deciding on when to buy in some of my posts. It was pointed out to me by a few readers that many may not really know what is 200 DMA, leave alone it’s significance.
Well, let me get down to the basics then – DMA full form is Daily Moving Average and 200 DMA is the Daily Moving Average over a 200 day period. You calculate it for Nifty by adding all the closing Nifty levels for the last 200 days and then dividing the sum by 200. So, obviously unless we are having a flat market for long the current level of Nifty will normally be different from the 200 DMA of Nifty. The other point to understand is this – we can have 200 DMA for any stock or for any other index as well. So 200 DMA of ITC is possible and so is 200 DMA of Sensex or CNX Mid cap index. Also, while 200 DMA is used very popularly you do have other indicators like 50 DMA, 30 DMA etc. These are also calculated as I have explained for 200 DMA.
Why is the 200 DMA the most popularly used indicator? Historically at some earlier point in time, stock markets used to be in business for 200 days a year. The 200 DMA would then represent the average value of the stock or particular index over the past year on a rolling basis. What is the significance of this? Well, one year is a fairly substantial period and the 200 DMA value will give you an indication compared to what the current market price (CMP) is. For example if the stock has been trading with a downward bias then in general CMP will be less than 200 DMA. It may not be a very good idea to buy such a stock when the 200 DMA is in a declining trend, even though the CMP by itself may look attractive. Similarly in a rising market the 200 DMA will show an increasing trend and it may make sense to consider buying any stock only after the 200 DMA trend gets to be a decreasing one, or at least flattens out considerably.
Let me try to explain this with the example of Nifty in the year 2015. On 3rd November 2014, Nifty was at 8324 and 200 DMA of Nifty was at 7191. Based on how the market has performed over the last one year, we can note the following:-
- On 12th February 2015, Nifty was at 8711 and 200 DMA for Nifty was 8312.
- On 22nd April 2015, Nifty was at 8429 and 200 DMA for Nifty was 8254
- On 23rd April 2015, Nifty was at 8398 and 200 DMA for Nifty was 8564.
- On 7th May 2015, Nifty was at 8057 and 200 DMA for Nifty was 8289
- On 12th June 2015, Nifty was at 7982 and 200 DMA for Nifty was 8360.
- On 25th August 2015, Nifty was at 7880 and 200 DMA for Nifty was 8456.
- On 7th September 2015, Nifty was at 7558 and 200 DMA for Nifty was 8430.
- On 29th October 2015, Nifty was at 8111 and 200 DMA for Nifty was 8378.
It is easy to see from this that the 200 DMA Nifty has started to decline for the last few days and this needs to be confirmed as a trend. Obviously, if the trend is confirmed then we are entering the buying zone for some of the Nifty stocks as well as for the MF schemes that have a high percentage of holding in the Nifty stocks. The maximum gap between the Nifty level and the 200 DMA was on 7th September but the Nifty found support at that level. I would say the 200 DMA has a high chance of declining further, based on whether BJP loses the Bihar elections. Crystal ball gazing is a tough task for our markets but I do think there is a possibility of the 200 DMA for Nifty reaching a level of 8100 or so by December end.
This will clearly mean that the Nifty will probably achieve levels higher than 200 DMA for the first time since 18th August, some time in January 2016. From now till then we will probably be in a strong buying zone. Of course, for individual stock or MF schemes you must also look at the 200 DMA levels for that stock or relevant index and see those trends for the past year. There are several web sites which will supply you with the relevant data you need to make buying decisions.
I hope with this I have been able to clear up the way in which you can make use of 200 DMA figures and trends. I will do another post on price triggers for stocks in the near future. But before that, I will write one about how I intend to use these indicators for my MF purchase, now that I have finally got out of SIP.