What is a Death Cross?
The death cross is one of the most feared chart patterns in technical analysis. It's a bearish signal that often indicates the start of a major downtrend or even a full-blown bear market. I've seen the death cross rear its ugly head time and time again over my years of trading. And let me tell you, it ain’t a pretty sight.
A death cross forms when a shorter-term moving average crosses below a longer-term moving average. The most common moving averages used are the 50-day and 200-day.
When the 50-day moving average falls below the 200-day, it's like a big flashing warning sign that screams "SELL" to traders. It signals that the current uptrend has lost steam and a new downtrend is likely taking hold.
Death Cross vs Golden Cross
The death cross is the “evil twin” of the golden cross. While a golden cross signals a bullish trend change when a short-term MA crosses above a long-term MA, the death cross does the exact opposite. These two chart patterns are like the yin and yang of technical analysis. Where the golden cross brings hope and optimism, the death cross strikes fear into the hearts of bulls everywhere.
Three Phases of Forming the Death Cross
The death cross doesn't just happen out of nowhere. It typically forms in three distinct phases:
The Pullback: After an uptrend, the price starts to falter and pull back.
The Crossover: As selling intensifies, the short-term MA crosses below the long-term MA, forming the actual death cross.
The Confirmation: Further price declines after the crossover confirm the pattern and indicate a true trend reversal.
I always look for these three phases when trying to spot a death cross in the making. The more textbook the pattern, the higher the odds it leads to some serious downside ahead.
How to Spot a Death Cross
Spotting a death cross isn't rocket science, but it does take a keen eye and some practice. Here are a couple of tips I've learned over the years:
One of the most infamous death crosses in recent history occurred on the S&P 500 chart in December 2018. The 50-day moving average sliced below the 200-day, leading to a swift and painful 20% correction.
It was a textbook example of how a death cross can signal major trouble ahead. The crossover was clean, the pullback was sharp, and the ensuing downtrend was relentless.
Not all death crosses are created equal. Sometimes you'll see a "false" death cross that quickly reverses. Other times, the pattern will lead to a prolonged and devastating downtrend.
I've found that two factors can help determine the strength and reliability of a death cross signal:
How far apart the MAs are when they cross. A wider spread often means a stronger signal.
How long it's been since the last death/golden cross. The more time has passed, the more meaningful the new cross becomes.
Death Cross Trading Strategy
So you've spotted a death cross, now what? Here's how I like to trade this ominous pattern:
Sell or short the asset once the death cross is confirmed with further downside. Don't try to front-run it.
Set a stop loss just above the cross point in case it ends up being a false signal.
Take partial profits on the way down at key support levels. No need to be greedy.
Trail your stop to lock in gains as the downtrend progresses.
The key is to be patient and let the market prove that the death cross is the real deal before putting on a full position. I've been burned by my fair share of false signals in the past.
Limitations of the Death Cross Indicator
As useful as the death cross can be, it's far from perfect. The biggest knock on the death cross is that it's a lagging indicator. By the time the cross actually happens, a good chunk of the down move has already occurred. It's kind of like getting a tornado warning after your house has already been leveled. Not exactly helpful.
There are a few other ways to calculate a death cross beyond the standard 50-day/200-day version. But in my experience, they aren't as effective.
For example, you could use a 20-day/50-day cross or even a 10-day/100-day. While these might be a bit more responsive, they also tend to generate a lot more false signals.
Death Crosses in the Stock Market
Historically, death crosses have been most meaningful and predictive in the stock market. They've called some of the biggest bear markets of the past century.
In addition to the 2018 example we already covered, there have been a few other notable death crosses in the stock market recently:
In March 2020, a death cross foreshadowed the pandemic-induced crash.
In May 2022, a death cross preceded a 20% decline in the S&P 500.
Of course, not every death cross leads to a crash. But the pattern has definitely proven its worth in the stock market.
If we zoom out and look at the entire history of the S&P 500, we can see that death crosses have occurred before every major bear market.
The crash of 1929
The "Black Monday" plunge of 1987
The dot-com bust in 2000
The financial crisis in 2008
They all featured death crosses leading into the carnage. So while the death cross may not be perfect, it's definitely a pattern that stock traders need to keep on their radar. Ignore it at your own peril.
Conclusion
So, while the Death Cross is not quite as terrifying as it sounds, it's still a powerful bearish signal that every trader should know about. But remember, it’s just one piece of the puzzle. It's not a crystal ball that can predict the future with 100% accuracy.
The key is to stay informed, stay disciplined, and don't let fear dictate your trading decisions. With a little knowledge and a lot of guts, you can face down the Death Cross and come out on top.
FAQ
Is a death cross bullish or bearish?
A death cross screams bear market ahead. It's when the short-term moving average dips below the long-term one, signaling sellers have taken over.
How reliable is death cross?
What is the Tesla Death Cross?
What is a golden or death cross?
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