The death cross-sell signal is the opposite of the more popular golden cross-buy signal. A golden cross occurs when the short-term moving average (i.e., 50-day ma) crosses the long-term moving average (i.e., 200-day ma).
A moving average crossover to the upside indicates the potential for a significant rally or the start of a sustainable bull.
A death cross-sell signal occurs when the short-term moving average crosses below its long-term moving average, signaling the potential for a significant sell-off and the beginning of a sustainable bear.
The death cross pattern is a lagging indicator, tracking the last 50 trading periods (i.e., 50-day ma) and the prior 200 trading periods (i.e., 200-day ma). Once a death cross appears on the chart, the index may have declined sharply from its high.
When deciding the extent of a death cross, expansion in trading volume indicates the severity of the selling pressure. Higher trading volumes at the time of a death cross signal and the days following the sell signal show traders and investors are actively selling.
The death cross often undergoes four distinct phases or stages.
Phase 1: The price reached a peak, with the price momentum trend starting to decline. Typically, this would imply sellers exceed buyers. The shorter-term moving average declines first, while the longer-term moving average retains its uptrend.
Phase 2: The price begins to decline faster and sharper, which leads to the crossover of the two moving averages. The short-term 50-day ma falls below the long-term 200-day ma, alerting the traders to watch for the start of a trend reversal favoring the downside.
Phase 3: It is a defining stage since it will decide the future trend. If the dip following the crossover is brief, and the short-term moving average moves decisively back above its long-term moving average, the death cross is a false signal. However, if the death cross signal leads to a short-term rally that fails to clear convincingly above the 50-day and 200-day moving averages, this solidifies the start of a bear decline. Traders will often turn defensive. However, investors typically wait for the rolling over (trending down) of the short-term (50-day ma) and long-term moving average (200-day ma) to confirm a bearish long-term trend.
Phase 4: It is also a critical stage since it reaffirms the transition from an uptrend to a downtrend. Pivotal supports have broken, reinforcing oversold rallies will be short-lived and fleeting. Typically, the 50-day and 200-day moving averages will turn into near-term to intermediate-term resistances. Downtrends, reaction highs, retracements, and previous pivotal breakdown levels can act as resistance zones on oversold rallies. The prevailing and dominant downtrend will persist if these overhead resistances remain intact.
In the past 100-plus years, death cross signals have an impressive record in predicting recessions and the start of stock market bear declines. For instance, a death cross occurred shortly before the crash of 1929. Bearish crosses also developed in 1938 and again in 1974. A death cross that occurred in 2001, coinciding with the dot.com bubble from 2000-2002. Ahead of the 2008 global financial crisis and recession, a death cross-sell signal also occurred. Recently, a death cross-sell signal in Mar 2022 led to a 27.54% SPX bear market decline.
The death cross-sell signal tends to be most effective when used by intermediate-to-long-term investors as it gives them time to protect their long-term capital gains before a bear market fully develops. As with technical indicators, it should accompanied by other technical indicators such as MACD, RSI, volume analysis, etc.
A brief review of popular U.S. market indexes, including SPX, INDU, NYA, COMPQ, NDX, MID, and SML, shows mixed signals. Death cross-sell signals occurred in indexes such as MID, SML, and NYA. INDU is within days/weeks of confirming a death cross-sell. SPX, COMPQ, and NDX have fared better than their peers, lacking visible signs of death cross-sell signals.
With nearly half of the U.S. indexes showing death cross-sell signals, will the remaining indexes soon confirm respective crosses?
If so, does this imply U.S. stocks are transitioning from bull markets to bear markets?