A death cross is a technical indicator that traders use in an attempt to predict bearish market momentum. A death cross is a breakout pattern that forms when a security's short-term moving average falling below its long-term moving average.
The name "death cross" comes from the X pattern that appears when this particular crossover is charted.
There are three specific phases of a death cross pattern. First, the security in question reaches the top of an upward trend, as buying activity becomes exhausted. In the second phase, the short-term moving average falls below the long-term moving average, which signals both a breakout and a new, downward trend. In the final stage, the new trend can become sustained, resulting in continued losses. In addition, the long-term moving average can serve as resistance.
While the declines that follow a death cross can be drawn out, they might also be temporary. One way technical analysts can seek to confirm the strength of a death cross's signal is to look at trading volumes. When one of these crosses takes place along with high volumes, it is considered a stronger signal.
Another variable that an investor can use in order to get stronger or weaker signals is the length of short-term and long-term averages. When looking to identify crossovers such as a death cross or golden cross, a trader could use short-term and long-term moving averages of 15 and 50 days, or 50 days and 200 days. Traders should keep in mind that longer moving averages generally coincide with trends that are longer and more robust.
Traders should keep in mind that many think of the death cross as being a lagging indicator, meaning that a technical analyst may not discover the signal until after a downturn begins. Past that, the new trend may be only temporary, as it could be overwhelmed by other market forces. If the downturn is only temporary, acting on the recently formed death cross could be disadvantageous for the investor.
Past that, some believe the death cross is not a solid indicator of what will happen, but rather that it's a more effective means of illustrating prior changes in trends.
Regardless, traders can use death crosses to single out low-price entry points for securities. For example, an investor might use a death cross to compare an individual stock's moving averages to those of a broader index such as the S&P 500.
Traders can use the death cross to identify bearish sentiment. However, they should keep in mind that a death cross may signal only short-term sentiment, and that the security in question could potentially rise in value after experiencing a temporary decline. Investors have a handful of tools they can use to confirm trends, including looking at volumes and using longer moving averages.
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Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…