Investors tend to focus more on market fundamentals than technical analysis, but there are a few technical indicators that carry weight across the board. For example, CNBC commonly cites the death cross as a bearish turning point for specific stocks or benchmark indices. These indicators tend to be less frequent than the day-to-day tools used by active traders, but when they occur, they can be a strong indicator of a change in long-term trend.
Let’s take a look at the death cross and its cousin, the golden cross, to see how they can be identified and used by both traders and investors.
What is a Death Cross?
The death cross is an ominously-named technical indicator that forms when a short-term moving average crosses below a long-term moving average to create a cross. In practice, most traders and investors watch for the 50-day moving average to cross below the 200-day moving average. The crossover is a sign that the long-term trend may be changing, which means investors may want to take profit and traders may want to consider a bearish position.
There are three stages to a death cross:
- Bullish Exhaustion: The price reaches the top of an uptrend and bulls become exhausted. Often times, this period is characterized by falling volume and volatility, as well as reversal candlestick patterns (e.g. dojis or hammers).
- Bearish Crossover: The short-term moving average falls below the long-term moving average, marking the start of a new bearish trend. While the price may have already been declining, the crossover confirms that the downturn is a reality.
- New Downtrend: The long-term moving average becomes a new resistance level as the bearish downtrend continues. Bearish volume may start to accelerate as short-sellers place bearish bets and long-term investors sell their positions.
Let’s take a look at a death cross in action:
In this example, the SPDR S&P 500 ETF (SPY) experienced a death cross on November 30, 2018, which signaled the start of a potential downturn. The benchmark index was already trading well off of its September highs, but the bearish indicator successfully predicted a more than 15 percent decline before the index recovered to trend line resistance in December and January.
Short-term traders may have taken a short position in the benchmark ETF or long-term investors may have purchased protective puts or otherwise hedged their portfolio against the decline.
What is a Golden Cross?
The golden cross is the opposite of a death cross—that is, a short-term moving average crosses above a long-term moving average to create a cross. Like the death cross, it’s usually the 50-day moving average crossing above the 200-day moving average. The crossover is a sign that the stock or index is likely to experience a turnaround, which means traders should consider long positions and long-term investors may want to add to their holdings.
There are three stages to the golden cross:
- Bearish Exhaustion: The price reaches the bottom of a downtrend and bears become exhausted. As with the death cross, this period is characterized by falling volume and volatility, as well as reversal candlestick patterns (e.g. dojis or hammers).
- Bullish Crossover: The short-term moving average crosses above the long-term moving average, marking the start of a new bullish trend. Again, while the price may have already been rising, the crossover serves as a confirmation of an uptrend.
- New Downtrend: The long-term moving average becomes a new support level as the bullish uptrend continues. Bullish volume may start to accelerate as traders buy into the trend and long-term investors add to their positions.
Let’s take a look at an example in action:
In this example, Twilio Inc. (TWLO) experienced a golden cross on March 12, 2018 and the stock rose nearly 140 percent over the ensuing year. The stock had already started to rise prior to the golden cross, but the signal confirmed that a long-term turnaround was in place.
Short-term traders may have decided to take a long position following the golden cross, while long-term investors may have added to their positions.
The Bottom Line
The death cross and golden cross are important indicators of a potential change in long-term trends. Short-term traders may screen for these crossovers and use them as a starting point for deeper analysis, while long-term investors may watch for crossovers in benchmark indices as a harbinger.
Like all technical indicators, it’s important to use the golden cross and death cross in conjunction with volume and other forms of technical analysis to confirm changes in trend and develop an exit strategy for the position.