The Stock Market is About to Experience a “Death Cross”

Helene Meisler pointed this out today:

The “death cross” is when, on the daily candlestick chart, the 50-day moving average (DMA) line dips below the 200-day moving average. It is generally an indication of a significant change in direction in the markets, and always precedes massive collapses in stock prices.

For instance, before the market collapse of 2008, the death cross told you there was probably going to be trouble ahead:

The 50 DMA (light blue) crossed below the 200 DMA in January 2008, and it would stay below the 200 DMA until mid-2009. From the time of the death cross in 2008 until the end of the bear market in 2009, the Nasdaq index would see a maximum decline of 48%.

Of course, by the time the death cross happened, the index was already down 15%. So if you’re looking for a leading indicator that will tell you when to sell, the death cross is not it. It’s not a “market top” indicator. It’s more of a “the market topped a few months ago” indicator. It’s more of a “last chance to get out before things get really bad” signal.

But the thing is, it’s not a foolproof signal. It’s not a reliable indicator that a bear market is indeed in its early stages. Because death crosses often give false signals.

While it’s true that in a bear market the 50 DMA will cross below the 200 DMA, we have also seen numerous DMA death crosses that did not precede massive, multi-year bear markets. Sometimes—actually, most of the time—markets rally and the 50 DMA climbs back up above the 200 DMA, and the bull market resumes its upward trend.

There was a death cross in 2010 that did not lead to a bear market:

The death cross happened on July 13, 2010. The 50 DMA stayed below the 200 DMA until October 21, 2010, then went back above it (this is known as a “golden cross”) and stocks climbed to new highs.

The thing is, prior to this 2010 death cross, the index had already fallen as much as 18% from its 52-week high, and by the time the death cross officially happened, the Nasdaq was already off the lows. It was still 11% off the highs, and there was still further downside of about 6% after the crossover took place, but if you used the death cross as a long-term sell signal in 2010, you made the wrong choice.

Same with 2011, when a death cross appeared to be presaging a major protracted bear market, but ultimately did not:

The death cross happened after the market had already been crushed and was 19% off the prior highs.

Certainly the market following the death cross was not a fun time to be invested, but 6 months after the death cross, the market was 17% higher. The golden cross happened on February 12, 2012.

In late 2012/early 2013, there was another very brief death cross that happened but had you sold stocks at that point, you would have missed out on a phenomenal rally that began almost immediately in early 2013, when the Fed began QE3:

So sometimes it’s very bad idea to use the death cross as a sell signal. In fact, oftentimes the death cross can be a great buy signal in that it tells you when the selloff has exhausted itself.

But that’s only if it’s just a correction. If it’s just a correction, you can use the death cross as a buy signal.

If it’s a bear market, though, then you would be buying at perhaps the worst possible time. So it’s very risky to use the death cross as a buy signal, and of course you can only know if it was a buy signal or a sell signal with the benefit of hindsight.

We saw another false signal death cross in 2015 and early 2016:

And in 2018:

And for the Covid Crash, because it was such a vicious and fast decline in stock prices, by the time the death cross happened, the market had already long since bottomed out and started going up again:

By the time of the death cross (April 15, 2020) the Nasdaq had already declined 33%, bottomed out, and was up 25% off the lows.

We can go back even further than this current market cycle and see there was a death cross in 2006 that was ultimately a false signal. The market would still be going up for another year afterward.

There were false death crosses in 2004 and 2005 as well.

However, the death cross that occurred in 2000 was certainly not a false signal:

Unfortunately, the Nasdaq had already peaked on March 10, 2000 and the death cross didn’t happen until June 13, when the index was already 28% off its highs, and had a few weeks prior to the death cross been down as much as 40% from the highs.

But still, from the time of the death cross in June 2000 until the bear market’s bottom point in early October 2002, the Nasdaq would decline a further 70%, for a grand total of -78% from the March 2000 peak level. So if you waited for the death cross to sell, you still avoided some serious losses.

The takeaway here is that the death cross is not a reliable sell-signal. Sometimes it can actually be better used as a buy signal, as it often happens right as the correction is bottoming out. We should not use the death cross signal alone to tell us when to sell stocks.

But we also know that there can’t be a bear market without a death cross, and so any time a death cross does occur, we should be on high alert because it’s possible a bear market has begun.

How can we apply this knowledge to our portfolios in the present moment? Again, by being alert and closely monitoring price action in the markets. If this is a correction, the death cross means we’re probably near the end of it.

If this is a bear market that we’re in now, though, then the death cross means it’s just beginning, and that things are about to get a lot worse from this point on.

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