Death crosses in technical analysis

Introduction

Stock prices move randomly over the short-term, but over the longer-term, the randomness decreases significantly. Market prices move in trends. Technical analysis tools help traders identify these trends. 

Death crosses help determine a change in market trends by analyzing moving averages. Some of the crossovers between moving averages are closely followed by traders, such as the golden and death crosses. 

What are moving averages? 

A moving average is the average of a range of prices of an asset over a given period. Moving averages are calculated by finding the arithmetic mean of an asset’s closing. This means summing the prices in the set and then dividing that sum by the number of price points you have. 

The most common time periods are 10, 50, 100, and 200 days. Moving averages (also known as just MA) are plotted alongside prices on a price chart where the x-axis reflects the time and the y-axis reflects the price, as shown in Figure 1. Moving averages form smooth lines in contrast to the patterns formed by the price which are spiky.

Figure 1

Moving averages follow prices in an uptrend, 50 MA moves above 100 MA and 200 MA, and in the downtrend, 50 MA moves below 100 MA and 200 MA. When these averages intersect, traders can anticipate changes in asset’s price direction. 

What is a death cross?

The death cross pattern appears when a short-term moving average drops below a long-term moving average. Typically, the 50-day moving average and the 200-day moving average are used to identify a death cross, as seen in Figure 2. 

Figure 2

The appearance of a death cross indicates a decline in short-term momentum and a trend toward lower prices. This tells you that the short-term trend is much weaker than the long-term trend, so the market can be considered bearish. The death cross is the exact opposite of another chart pattern known as the golden cross.

Death cross and the bear market

A death cross has appeared before all the most severe bear markets over the course of the last 100 years. This includes the bear markets of 1929, 1938, 1974, and 2008. However, death crosses have also appeared when the market has only suffered a correction, meaning the market dropped by at least 10% but less than 20%.

Death crosses can appear in all assets, not only in major indices such as the S&P 500. Figure 3 shows that Apple’s stock had a death cross in December 2018, then declined more than 18% after that death cross. 

Figure 3

Figure 4

Bitcoin had a death cross in January 2022, then fell by 33% after that signal, as seen in Figure 3. To summarize, the death cross happens when a bullish trend reverses and a bearish trend is underway. It can take some time for it to print, depending on how close the two moving averages are. In general, the steeper the bullish trend, the longer it will take for a bearish cross to happen once the price starts reversing.

Limitations of the death cross

The death cross is that the pattern sometimes won’t show up until a security’s price has fallen well below its peak. To alter a death cross calculation to see the downtrend a little sooner, some investors say that a death cross occurs when the security’s trading price (not its short-term moving average) falls below its 200-day moving average. For experienced traders, investors, and analysts, a death cross pattern for a stock is most meaningful when combined with, and confirmed by, other technical indicators.

The death cross is a lagging indicator, so in some cases, the bearish times it forecasts may have already happened. When a death cross isn't backed up by other technical indicators, it may be a sign of a short-term downtrend, and investors may want to "buy the dip."

Successes of the death cross

According to Fundstrat research cited in Barron's, the S&P 500 index was higher a year after the death cross about two-thirds of the time, averaging a gain of 6.3% over that span. That's well off the annualized gain of 10.5% for the S&P 500 since 1926 but hardly a disaster in most instances. 

The track record of the death cross as a precursor of market gains is even more appealing over shorter time frames. Since 1971, in 22 instances where the 50-day moving average of the NASDAQ Composite index fell below its 200-day moving average were followed by average returns of about 2.6% over the next month, 7.2% in three months, and 12.4% six months after the death cross. That’s roughly double the typical NASDAQ return over those multiple time frames, according to Nautilus Research.