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A death cross indicates a bearish move and is formed when you see a short-term moving average (usually a 50-day period), cross over below the long-term moving average (usually a 200-day period) on a chart although traders are free to use any periods they wish, provided that there is a relatively big difference between the short-term period and long-term period.
…Using the death cross with a 50-period and 200-period…has reliably predicted some of the most severe bear markets that have occurred – the GFC in 2008, the Great Depression of 1929, and the market crashes of 1938 and 1974. It is not infallible, however, as many traders learned in 2016 when a death cross formed causing many traders to exit the market in expectation of a prolonged fall, only to see a relatively short and sharp 10% correction and a bull market heading into 2017.
As with many indicators, the death cross is a lagging indicator…[and,] in many cases, a fall of 15-20% has already occurred before a death cross is formed [and, as such,] serves more as an indicator of a severe bear market forming, rather than as a reliable indicator of all price declines.
There are two main ways traders can leverage a death cross in their trading.
- The first is as a filter for spotting stocks which could become undervalued due to short-term fear-based trading…as the death cross can often create a self-fulfilling prophecy of further price declines as other traders react to it.
- The second way to use the death cross is as a warning system by applying it to the general market. That is to say, once the general market (e.g. the S&P 500) experiences a death cross, it might be a good time to unwind positions or put hedges in place to protect against major bear market corrections.
The death cross is a highly flexible indicator in that it can be applied across multiple time intervals [be it] a 50-day, 50-hour or even 50-minute moving average, allowing traders to exploit both large and slow trends, down to small and rapid intra-day trends.
Conclusion
The death cross [is usually when] a 50 period short-term moving average crosses under a 200-period long-term moving average signaling that a bearish trend has formed. While not always reliable for smaller moves of less than 20%, it has been found to predict some of the largest bear markets experienced in the last century.
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The “death cross” occurs when the 50 daily moving average falls below the 200 daily moving average and is seen by mainstream financial media as a BIG bearish signal. It isn’t. It is actually more often a medium-long term bullish signal than a bearish signal. Below are all the S&P 500’s death crosses that have occurred over the past 20 years and they substantiate that it isn’t a useful indicator. Take a look.
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Editor’s Note: The original article by Gavin McMaster has been edited ([ ]) and abridged (…) above for the sake of clarity and brevity to ensure a fast and easy read. The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor. Also note that this complete paragraph must be included in any re-posting to avoid copyright infringement.
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