What is a death cross?
The death cross is a technical chart pattern that indicates the possibility of a major selloff. The death cross appears on a chart when a stock’s short-term moving average crosses below its long-term moving average. Typically, the most common moving averages used in this pattern are the 50- and 200-day moving averages.
- The death cross is a technical chart pattern that indicates the potential for a large sell-off and has proven to be a reliable predictor of some of the harshest bear markets of the past century, including 1929, 1938, 1974, and 2008.
- The death cross appears on a chart when a stock’s short-term moving average, usually the 50-day moving average, crosses below its long-term moving average, usually the 200-day moving average.
- The death cross can be contrasted with a golden cross that indicates an upward price movement.
The death cross indicator has proven to be a reliable predictor of some of the harshest bear markets of the last century – in 1929, 1938, 1974, and 2008. Investors who exited the stock market at the beginning of these bear markets avoided large losses. which reached 90% in the 1930s. Because a death cross is a long-term indicator, unlike many short-term chart patterns like the doji, it carries more weight for investors concerned about locking in gains. before a new bear market starts. An increase in volume usually accompanies the appearance of the death cross.
What does the cross of death tell you?
The death crossover occurs when a short-term moving average (typically 50-day SMA) crosses a major long-term moving average (typically 200-day SMA) to the downside and is interpreted by analysts and traders as a sign of a definite bearish turn. in a market. Here’s an example of a death cross on the S&P 500 in December 2018:
The name of the death cross is derived from the X shape created when the short-term moving average falls below the long-term moving average. Historically, the pattern precedes a prolonged recession for both the long and short-term moving averages. The death cross is a sign that short-term momentum in a stock or stock index is slowing, but it is not always a reliable indicator that a bull market is about to end. There have been many occasions when a death cross appeared, such as in the summer of 2016, when it turned out to be a false indicator. Those who ran out of stocks during the summer of 2016 missed the sizable stock market gains that followed throughout 2017. The 2016 death cross example did indeed occur during a technical correction of around 10%. , which is often considered a shopping opportunity (known as “buying in the bathroom”).
There is some variation of opinion as to what precisely constitutes this significant moving average crossover. Some analysts define it as a crossing of the 100-day moving average by the 30-day moving average, while others define it as the crossing of the 200-day average by the 50-day average. Analysts also watch the crossover occurring on the lower time frame charts as confirmation of a strong and continuing trend. Regardless of variations in the precise definition or time frame applied, the term always refers to a short-term moving average, which was at a higher value, crossing below a significant long-term moving average.
Example of a death cross
The following is a historical example of two death crosses that occurred for Facebook Inc. (FB) shares in 2018. After the first in April 2018, the shares turned around and began a prolonged rally. However, the second in September 2018 signaled a protracted bear market for stocks.
Looking back at the most punishing bear markets of the last century, it appears that the death cross is best held once the market has already lost 20% of its value. In those cases, investors who fled the stocks minimized their losses. But for smaller corrections of less than 20%, the temporary appearance of the death cross may reflect already recorded losses and thus indicates a buying opportunity.
Cross of death against cross of gold
The opposite of the death cross occurs with the appearance of the golden cross, when the short-term moving average of a stock or index moves above the long-term moving average. Many investors see this pattern as a bullish indicator. The golden cross pattern usually appears after a prolonged downtrend has been exhausted. As with the death crossover, investors should confirm the trend reversal after several days or weeks of price movement in the new direction. Much of the pattern trading process is self-fulfilling behavior, as trading volumes increase with the attention of more investors who are driven in part by an increase in financial news about a particular stock or the movement of a stock. index.
Limitations of the use of the Death Cross
All indicators are “lagging” and no indicator can truly predict the future. As seen in the Facebook example above, the first death cross produced a false signal, and a trader who placed a short at that point would be in short-term trouble. Despite their apparent predictive power in forecasting previous big bear markets, death crosses regularly produce false signals as well. Therefore, a kill cross should always be confirmed with other signals and indicators before placing a trade.