Market Phase – Going Beyond The Death Cross

There are many ways to use indicators to help determine when the market is within a bull or bear mode. A common method that works well on trending markets over the long-term has been the so-called death cross and golden cross (Death/Golden Cross) indicator. This topic was discussed in a former article called,

The Death Cross – What You Need To Know. I encourage you to read the article which is based on backtesting the indicator on the S&P 500.  Below are the rules used by the Death/Golden Cross to divide a market into a bullish or bearish mode.

Bull Market = 50-Period SMA > 200-Period SMA 

 Bear Market = 50-Period SMA < 200-Period SMA 

In short, the Golden Cross has been a great signal for long-term market strength while the Death Cross often signals market weakness. Simply using the Death Cross as a signal to close all long positions within your retirement and brokerage accounts has historically saved your account from painful drawdowns. But can we improve upon this idea?

Within this article I’m going to build upon the Death/Golden Cross concept. I recently became inspired to write this article after reading “Defining The Bull And The Bear” by Chuck Dukas. Chuck developed a simple and interesting method to take the Death/Golden Cross to the next level. I’m going to reconstruct his concept using EasyLanguage programming code and backtest it to see how effective it is.

Within Chuck’s article, he uses a 200-period simple moving average (SMA) and 50-period SMA as the two primary indicators. These are the same indicators used by the Death/Golden Cross. However, where the Death/Golden Cross uses the crossing of these averages to generate their respective bull and bear signals, Chuck goes further by breaking up both the bear and bull markets into six different Phases.

1.   Recovery Phase
2. Accumulation Phase
3.   Bull Phase
4.   Warning Phase
5.   Distribution Phase
6.   Bear Phase

These phases take into account the relative positions of both the daily closing price and the two moving averages. This finer granularity can be used as a guide to deploy your money in the markets.

Recovery Phase = 50-Period SMA < 200-Period SMA and Close < 200-Period SMA and Close > 50-Period SMA

Accumulation Phase = 50-Period SMA < 200-Period SMA and Close > 200-Period SMA and Close > 50-Period SMA

Bull Phase = 50-Period SMA > 200-Period SMA and Close > 200-Period SMA and Close > 50-Period SMA

Warning Phase = 50-Period SMA > 200-Period SMA and Close > 200-Period SMA and Close < 50-Period SMA

Distribution Phase = 50-Period SMA > 200-Period and SMA and Close < 200-Period SMA and Close < 50-Period SMA

Bear Phase = 50-Period SMA < 200-Period SMA and Close < 200-Period SMA and Close < 50-Period SMA

For a pictorial representation of some of these phase you can see the “Bull Phase” and “Warning Phase” listed below.

 On the opposite end of the spectrum, below is an image of price action in “Bear Phase”,  “Recovery Phase” and “Accumulation Phase.” 

The original article goes into much more explanation behind each phase but let’s stick with the basics which are very quantifiable.  These simple rules can now be programmed into an automated trading system and tested. This system will be called the Market Phase System. For our examples I’m going to be buying the S&P 500 cash index ($SPX.X) and deduct $30 per round trip for slippage and commissions. The system will be going long only and will scale into a position based upon the following rules:

Buy X shares when we advance from Recovery Phase into Accumulation Phase.

Buy X shares when we advance from Accumulation Phase to Bull Phase.

The number of shares will be adjusted based upon an ATR calculation and will risk no more than $2,000 per trade with an account size of $100,000. We will exit our entire position when we enter a Bear Phase. The exit rule is basically the same as the Death/Golden Cross. Also, the entry rules are similar. The only difference is with the Market Phase System we are scaling into our position while the Death/Golden Cross purchases all shares ($4000 risk per trade) when the signal occurs. In short, the Market Phase System allows us to scale into our position during the Accumulation Phase instead of waiting until we transition into a Bull Phase. So, how do these two systems compare?

Golden Cross vs Market Phase

Since the inception of $SPX.X it has been difficult to beat following the Death/Golden Cross signals. The Market Phase System holds its own. It produces more than twice as many trades, but remember that’s also due to the fact it scales into the full position and TradeStation reports each entry as an individual trade. That’s why we have over twice as many trades. But the system does hold up well.

One tweak I would like to make to the Market Phase System is to substitute the closing price with a price proxy. As we know, the daily closing price of SPY can be rather choppy resulting in whipsaws. Let’s try to reduce some of these false signals and see if we can improve the system’s performance.

For our price proxy let’s take the exponential average of the last five days. But don’t use the closing price of SPY. Let’s take an average of the daily high, daily low and the closing price. With this method we are taking into account the size (range) of the daily bar. Here is the formula.

 PriceProxy = Exponential Average ( (High+Low+Close)/3, 5 )

We will use the value of PriceProxy instead of the daily closing price in all our calculations. This is done to smooth out the short-term price noise. Below are the results.

Golden Cross Vs Market Phase