Fans of technical analysis in financial market trading advocate not only for the analytical but also the predictive value of indicators and their combinations. According to its founder Charles Dow, the price reflects everything, and therefore, the mathematical dependencies (indicators) derived from price charts can highly likely predict future market behavior based on historical data. This is especially true for trend indicators, which reliably filter out insignificant price spikes and accurately reflect chart trends. One of the technical analysis patterns that has been used for decades and proven its usefulness is the “Death Cross.”
From this article, you will learn:
- What a Death Cross is in trading. The basic principles of forming a Death Cross and its significance for predicting bearish trends in financial markets.
- Advantages and disadvantages of the Death Cross. How it reliably filters out short-term price fluctuations and why its formation occurs with a delay, potentially leading to false signals.
- Practical application of the Death Cross in trading. Examples of using this signal, its historical effectiveness, and possible modifications for obtaining quicker signals.
Death Cross Meaning
The “Death Cross” is a combination of indicators that suggests a high probability of a bearish trend development. Since it is formed from two trend indicators, it is considered a reliable signal. The classic “Death Cross” is observed on daily price charts (timeframe – 1 day) when two simple moving averages (Simple Moving Average, SMA) intersect:
- The fast one, with a period of 50 days.
- The slow one, with a period of 200 days.
The Death Cross forms as follows:
- After an uptrend and possibly a phase of market consolidation, the slow SMA is below the fast SMA on the chart.
- The fast moving average changes direction.
- The SMA50 crosses the slow moving average from top to bottom.
The moment these lines intersect on the chart is called the “Death Cross.” Since both indicators used are trend indicators, their directional change is interpreted as a trend reversal. In fact:
- The change in direction of the fast moving average indicates that the short-term trend has already changed.
- The crossing of the filtered SMA50 price chart through the slow moving average (SMA200) indicates a high probability of a long-term trend change.
- The change in both short-term and long-term trends is a reliable signal of a bear market.
Thus, traders should consider closing long positions and initiating asset sell trades.
On price charts, the MA50 and MA200 can also intersect in the opposite direction. This situation is called the “Golden Cross” and is considered a signal of a bullish trend (for opening long positions).
The main advantage of the “Death Cross” is its reliable filtering of short-term insignificant price fluctuations due to the large periods of the moving averages. As a result, its appearance indicates not local processes in the market, but global trend changes that can last for months or even years.
The predictive value of the “Death Cross” is often discussed because its appearance on the American stock market chart (observable via the S&P 500 index) has predicted some of the harshest crises over the past 100 years. For instance, it can be seen in historical data in 1929, 1938, 1974, and 2008. Investors who exited long positions based on this signal had a good chance of significantly limiting losses (or preserving some of their accumulated profits) even during the Great Depression.
Death Cross Technical Analysis
A trading system using the “Death Cross” signal is straightforward. When it forms (after the close of the day it appears, at the opening of the next), the investor:
- Closes long positions on the asset where the “Death Cross” has formed.
- If desired and possible, enters short sales on this asset.
However, the “Death Cross” as a trading signal has two significant drawbacks:
- Due to the large periods of the moving averages, formation occurs with a significant delay relative to the actual start of the bearish trend.
- The large lag can lead to false signals. It’s possible for the downward trend on the chart to end before or immediately after the “Death Cross” appears, causing traders and investors losses.
A good example of a false “Death Cross” can be seen with Facebook (now Meta) shares on April 13, 2018. The company’s stock decline that began in late February was so powerful that the SMA50 reversed, and a Death Cross formed on April 13. However, the decline, while powerful, was short-lived. By April 25, the quotes were rising, and by June, a “Golden Cross” had formed on the charts. Investors who closed positions based on the “Death Cross” signal recorded losses or missed out on almost the entire recovery.
The “Death Cross” formed on FB shares on September 18, 2018, was effective and allowed investors to exit long positions in time, while speculators profited significantly from shorts.
To filter out false signals:
- Look for confirmation in volumes or the order book.
- Analyze price charts and indicator types more thoroughly. In the described example of the false “Death Cross” on FB charts, it formed on an upward movement of the slow SMA, while the valid signal appeared on a downward section. It also works well with small inclines of the slow curve (almost horizontal sections).
Investors aiming for shorter-term investments often use modifications of the “Death Cross” for faster and more frequent signals:
- SMA50 and SMA100.
- SMA20 and SMA100.
- SMA20 and SMA50.
However, remember that reducing the period of moving averages diminishes their filtering ability, increasing the number of false signals.