What is a Death Cross?
A death cross is a chart pattern that is believed to indicate the transition from a bull market to a bear market. This technical indicator occurs when a security’s short-term moving average (50-day) crosses from above to drop below of its long-term moving average (200-day).
The indicator gets its name from the alleged strength of the death cross pattern as a bearish indication – in short, traders who believe in the pattern’s reliability say that a security is “dead” once the bearish crossover occurs.
Connection to the Golden Cross
The death cross is the exact opposite of another chart pattern known as the golden cross.
The golden cross occurs when the 50-day moving average of a security crosses above the 200-day moving average. The golden cross, in direct contradiction to the cross of death, is a strong bullish market signal, indicating that rising security prices – and ultimately gains – are on the horizon for buyers.
Three Phases of Forming the Death Cross
There are three primary phases in the formation of the cross of death pattern (just as there are for the formation of the golden cross).
The first phase involves the upward trend of a security, where it begins to reach its peak as buying momentum tapers off. Then, the price begins to fall as sellers gain the upper hand in the market.
The second phase involves the decline in the security’s price to a point where the actual death cross occurs, with the 50-day moving average crossing over to the downside of the 200-day moving average. The downside breakout signals a new, bearish long-term trend in the market.
The final phase involves the continuation of the downward movement in the market. The length of the downward trend needs to be sustained long-term in order for a true death cross to be deemed to have occurred. If the period of downward momentum is short, then the cross of death, in that case, is considered a false signal.
Determining the Strength of a Death Cross Signal
The death cross pattern is more useful to market analysts and traders when its signal can be confirmed by other technical indicators. One of the most popular technical indicators to confirm a long-term trend change is trading volume. The bearish pattern is considered a more reliable signal if it occurs alongside high trading volumes.
A Lagging Indicator
Many analysts and traders put a limited amount of reliance on the death cross pattern because it is often a very lagging indicator, occurring significantly after the point at which a market has made the turn from bullish to bearish. Because the crossover of the 200-day moving average by the 50-day moving average can be such a lagging indicator, some traders consider the pattern to occur when the price falls below the 200-day moving average, as this often occurs well in advance of the 50-day moving average crossover to the downside.
While there are naysayers to almost every technical indicator, the cross of death can be an important indicator for investors and analysts, helping them determine the shift to a long-term downtrend in a market.
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