Death Cross
Occurs when a security’s short-term moving average falls below its long-term moving average, indicating a fall in its value and alerting investors about the bearish signal.
A death cross refers to a chart pattern suggesting a price fall. Specifically, when the short-term moving average (typically 50 days) dips to levels below the long-term moving average (typically 200 days), it is said to be occurring.
Keep in mind that a moving average refers to the price of a security over a certain period. The moving average does not include weekends (Saturdays and Sundays) or other holidays when the markets are closed.
This technical indicator marks the transition of the market from bullish to bearish.
It is called so because when this technical indicator occurs, the short-term moving average line intersects or “crosses” the long-term moving average line in the chart.
Further, investors that believe the indicator is credible also believe that once the two lines cross in such a manner, the security is essentially “dead.”
Yet, according to historical data, its occurrence is often followed by a rebound in the security’s price, with returns that are above average.
It is also important to note that the indicator preceded several bear markets, including those in 1929, 1938, 1974, and 2008.
When an index like the Standard and Poor’s 500 (S&P 500) or NASDAQ experience a death cross, there is a fall in the prices of all stocks in that index.
Phases of the Death Cross
Three key phases mark the development of this indicator. The following section briefly goes over each of them.
- In the first phase, the asset's price reaches its peak as the pace of its purchases slows down. Instead, the number of sellers begins to increase until there are more sellers than buyers, and the asset price starts to dip.
- The second phase marks the fall of the asset price till it reaches the death gross and plunges to levels below its long-term moving average. This usually happens when the 50-day moving average reaches a level less than the 200-day moving average and signals that the market is becoming bearish.
- The third and final phase of this phenomenon occurs as the prices continue to slip, and this downward trajectory is sustained for longer. The asset then loses its value in the market. If the downward trend does not sustain for a long time period, the bearish indicator is considered a false signal and can be negated.
The three phases described above are essential for a security to be declared “dead.”
When does it occur?
This indicator is a lagging indicator. It occurs once the price of a security has already deteriorated, showcasing its past performance.
The death cross does not signal the present or future movements of the asset. Yet, many proponents of this phenomenon argue that historical data suggests it occurred before several stock market crashes/bear markets.
This is a sample selection bias, i.e., considering only those data points that support the argument.
Considering only the years where markets have been bearish does not account for instances where the technical indicator occurred but was a false alarm or a mere market correction.
When such a cross appears in conjunction with other indicators, such as trading volume, it becomes more significant for analysis.
When trading volume is high, more investors follow the downward trend signaled by the cross and sell that security.
Downward momentum in poor markets is often an indication of deteriorating fundamentals.
Given this information, it makes sense that the indicator offers a more valuable bearish market timing signal after 20% or more market losses.
However, this indicator's historical performance shows that it is not a leading indicator of market weakness but rather a coincidental one.
A real-life example
To strengthen our understanding of this price chart pattern, let us consider the following real-life example observed in the price of Bitcoin.
Like indexes and stocks, cryptocurrencies can also experience a death cross. In fact, in June of 2021, Bitcoin fell victim to this very phenomenon.
Bitcoin’s 50-day moving average dropped below its 200-day moving average, and the cross occurred.
The cryptocurrency price peaked at $63,000 in April 2021 and fell to only $31,000 by June, losing nearly half of its gains.
However, this was not the only time Bitcoin experienced this bearish cross.
The phenomenon occurred again in January 2022, when the price of Bitcoin peaked, followed by a sharp decline.
From the above example, it is clear that a death cross occurs when bullish trends reverse and bearish investors crowd the market for the asset.
The time it takes for the cross to be reflected in the chart depends on the steepness of the bullish trend that preceded the drop. The steeper the bullish trend, the longer it takes for the cross to occur.
Assessing the strength of the signal
This bearish cross, coupled with other technical indicators, is often used by market analysts and/or traders to determine market trends and signals.
As mentioned previously, trading volume is a good way to determine how strong the signal of a death cross is. Therefore, the signal will likely be more credible if the trading volume is high.
Alternatively, momentum indicators like the moving average convergence divergence (MACD) indicator are also a good way to tell whether a signal is reliable.
It depicts the relationship between security’s long-term and short-term moving averages.
The price chart shows MACD as two lines that fluctuate without boundaries.
A bullish trend is signaled by the market when MACD crosses above zero, whereas a bearish trend is signaled by the market when MACD falls below zero.
Similarly, if MACD appears to rise from below zero, the market is said to be bullish. On the other hand, if MACD falls from above zero, the market is said to be bearish.
Such momentum indicators are known to perform well because a long-term trend often loses some of its strength shortly before the market turns.
Differentiating between Death and Golden Cross
The golden cross phenomenon is the opposite of the bearish indicator we discussed. While the death cross signals bearish trends, the golden cross is a sign of optimism in the market.
A golden cross is formed when the short-term moving average rises above the long-term moving average, indicating an upward trend in the price.
The golden cross may also signal that a long-lasting decline in the market has lost its pace.
It demonstrates how much stronger the short-term trend is than the long-term trend. However, the price will have risen significantly from the bottom before the golden cross occurs.
Just as Bitcoin has gone through death crosses (as discussed in the example earlier), it has also rallied in golden crosses.
In April 2019, after Bitcoin hit rock bottom, the golden cross occurred, sending the cryptocurrency up to a high of $13,000.
It is important to note that this optimistic signal can also be a sign of market correction instead of an indication of a trend. Hence, it is important to consider other technical factors when deciding whether or not to invest in an asset.
Limitations
Like any other concept in the world of finance, it has its shortcomings. The following section goes over some of these limitations.
1. Market signals do not hold as much predictive value as we would like
If the death cross were indicative of a security’s future value, traders would most certainly take advantage of it. There would not be much room left for arbitrage opportunities.
However, data suggests that this concept is more of a short-term signal of a bearish market.
2. It only shows the past performance of an asset
This is due to it being a lagged indicator. Hence, predictions of a bear market shown by the indicator may already have passed.
This means that when investment decisions are made, investors should be cautious about using this indicator.
3. The death cross can often be a false alarm
If other technical indicators do not accompany the bearish signal, it might just be a sign of a short-term fall. In this case, traders may be tempted to “buy the dip” to realize gains in the future.
4. On its own, it is not sufficient to make an investment or trading decision
Investors should analyze trends through other indicators before buying or selling a security.
- It occurs when a security’s short-term moving average falls below its long-term moving average, indicating a fall in its value and alerting investors about the bearish signal.
- When analyzing charts via this indicator, it is important to consider other indicators, such as trading volume and MACD.
- Most investors follow the downward trajectory and sell that security when the trading volume is high.
- In this way, these indicators can also assist in determining whether the cross is credible or just a false signal.
- The golden cross is a sharp contrast to the death cross. It occurs when the short-term moving average rises above the long-term moving average, indicating that the bulls in the market are waking up.
- The death cross has shortcomings; hence, it should be used cautiously.
- Being a lagging indicator, it only displays an asset's historical performance. As a result, the indicator's predictions of a bear market may have already occurred.
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