In another sign pointing to a market and economic recovery, for the first time since Dec. 26, 2007, the S&P 500 has broken above its 200-day moving average. What’s the big deal?

What does it mean? Some investors are skeptical that this rally is for real. There’s been talk of a double-dip recession. Some think this might be a market waiting to bite as soon as you put your hand in. And who knows – it could. It could end next week, or it could continue to sit above its trend line for the next year.

But understanding the role of the 200-day moving average when it comes to managing your risk shows why this key crossover matters.

We use the 200-day exponential moving average, which is more sensitive to recent changes in the market,

The idea of any trend line, whether it’s the 200-day or something shorter, is that when a given position moves above it, it’s a signal that a primary trend is in place. As this primary trend continues to move higher, it’s a signal that it’s likely that it will continue to do so. On the flip side, if the primary trend begins to slope downward, it’s a signal that the trend could be coming to a close.

There’s no such thing as a “sure thing” when it comes to technical indicators, though. Just because a position heads above its long-term trend line doesn’t necessarily mean it’s going to stay there, nor does it mean that it’s going to stay there for any specific length of time. The trend could disappear next week or next year, which is why it’s important to monitor your positions.

You can protect yourself by having an entry (and an exit) strategy. The S&P 500 crossing its trend line is step in the right direction. On the other hand, the skeptics may be correct in saying that this may not stick. No one knows for certain.

Since no one knows, it’s wise to just stick with the trends and not fight them. Our strategy works this way:

• When a position crosses its 200-day moving average, it’s a signal to consider buying
• When a position dips below the 200-day or 8% off the recent high, whichever comes first, it’s a signal to let go

Having strategies such as these can serve as some protection on several fronts: it can remove the emotion factor from your decision-making process, it can have you in the markets in time for any potential long-term uptrend and it provides a cap on potential losses so that you don’t have to ride a position all the way to the bottom.

Tags: ETF 101, S&P 500, Trend Following