The death cross is one of the many technical chart patterns used by traders to predict market movements. A death cross is an indicator of a potentially major sell-off. It appears on a chart when the stock’s short term moving average crosses under its long term moving average. Typically, the most common moving averages used in this pattern are either 50-day or 200-day moving averages. The death cross has proven itself a reliable predictor as it has been a telltale sign in most of the severe bear markets seen in the last hundred years, including the crash of 2008.
Going back to the 1930s, investors who used a death cross trading strategy got out of the stock market at the beginning of the bear market avoided massive losses that were as high as 90%. A death cross serves as a long term financial indicator instead of a variety of short term indicators such as Doji. Death cross trading carries more weight for investors concerned about locking in their gains before a new bear market gets underway.
An increase in volume commonly accompanies the appearance of a death cross. A golden cross is the converse of a death cross and indicates a bullish price movement’s potential. In a golden cross, the short term moving average goes over a long term moving average, hence serving as a potential bullish indicator. The golden cross typically shows up after a downtrend that has been prolonged and eventually runs out of momentum.
What Does The Death Cross Reveal?
The death cross commonly occurs when a short-term moving average, typically 50-day SMA, goes over a major long-term moving average to the downside. The short term moving average is typically a 50-DAY SMA, while the long-term moving average is typically a 200-day SMA. Traders and analysts commonly interpret the death cross as signaling a final bearish turn in the market. Here are some details about how the death cross looks and what it signifies.
The death cross name is derived from the X shape created when the short term moving average goes under the long term moving average. Historically, this pattern is followed by a prolonged downturn for both moving averages. The death cross signals that the short-term momentum in a stock or stock index is slowing down. However, the death cross is not always a reliable indicator signaling the end of a bull market.
Many times, a death cross appeared, like the summer of 2016, where it proved to be a false indicator of the bearish turn. Those who trusted the death cross and got out of the stocks in 2016 missed out on sizable market gains followed throughout the year of 2017. In fact, the 2016 death star example occurred during a technical correction of about 10%. This outcome is frequently seen as a buying opportunity, otherwise known as ‘buying on the dip.’ There is also variation when it comes to what constitutes a meaningful moving average crossover.
Certain analysts define a moving average crossover between a 100-day moving average and a 30-day moving average. On the other hand, others describe it as the crossover of a 50-day moving average and a 200-day moving average. Analysts also watch for the crossover occurring on a lower time frame chart. This chart will serve as confirmation of a strong and ongoing trend. Regardless of variations in the precise definitions and the timeframe applied, the term always refers to a short term moving average, which was at a higher value, and crosses below a major long-term moving average.
To some extent, every indicator can be “lagging” and, at times, will not accurately predict the future of the market. As seen historically, even a death cross is subject to false predictions. Traders who blindly choose to abide by it may be losing out on huge returns, as has occurred in the past. Despite its predictive power, which is quite apparent, death crosses ultimately can produce a false signal. As with any technical indicator, the death cross much also be confirmed by looking for other market indicators.