The Death Cross – What You Need To Know

On August 31, 2015 an indicator called “Death Cross” appears on the S&P cash index. This has not happened since 2011. The Death Cross is simply when a 50-period simple moving average (SMA) crosses under a 200-period SMA on a daily chart. Such a signal is believed to warn of upcoming bearish market activity. The opposite signal is called a “Golden Cross”, and is alleged to warn of bullish market activity. But does the Death Cross or the Golden Cross hold any merit? What can we learn from these signals and how can we use this information in our trading? In this article I’m going to demonstrate why the Death Cross is important and why its opposite signal, the Golden Cross, may be even more important.

Both the 50-period SMA and the 200-period SMA are well known moving averages. Thus a lot of eyes are watching price around these levels. It’s no surprise when these moving averages cross the event and might be worth noting.  One way to test how well the Death Cross and Golden Cross perform historically  is to create a simple trading system based upon these signals. Using TradeStation’s EasyLanguage coding language it’s simple to create a trading system that is always in the market switching between a long position and a short position based upon a moving average crossover. Here is what the entire trading system code looks like:

if ( Average(Close,50) crosses above Average(Close,200) ) then buy(“Golden Cross”) next bar at open;
if ( Average(Close,50) crosses under Average(Close,200) ) then Sell short(“Death Cross”) next bar at open;

Below is the most recent Death Cross. You can see the faster moving average (black) has dipped below the slower moving average (red).

Testing Environment

Before getting into the details of the results, let me say this: all the tests within this article are going to use the following assumptions:

• Amount dedicated to each trade $100,000
• Long only
• The P&L is not accumulated
• $30 was deducted per round-trip for commissions

In order to get a long-term feel for this system I’m going to use the S&P500 cash index going back to 1961. The trading system will trade a fixed dollar amount to each trade. In this case, $100,000.

Before we start looking at some of the numbers I want to break this study into two parts: Shorting a Death Cross vs. going long the Golden Cross. What interests me is how well the system functions going long vs going short. In other words, what does the SMA cross tell us about a bearish cross vs a bullish cross? Are they different?

Shorting The Death Cross

Since we recently experienced a Death Cross, let’s first look at shorting every Death Cross signal. The equity graph is below and it’s not pretty.

What does this tell us? To simply short the Death Cross may not be very profitable. We can see the equity curve hangs around the zero line for decades. In recent times it has climbed from negative territory to just below the zero line. Yet, there is nothing in this picture that suggests we have an edge simply shorting the S&P index upon a Death Cross signal. Below is a graph of the week drawdown experienced while shorting the Death Cross.

This is an ugly picture where you have many trades where drawdowns reached 30% or more. At some points you have to endure drawdowns of up to 65%. That’s massive heat you must take and what is your reward? Not to make any money! Simply using the Death Cross and Golden Cross as a timing signal does not appear to be a good use of your time.

Going Long The Death Cross

Maybe we should be taking the Death Cross as a buying opportunity? Why not? We want to be opposite the crowd, right? Below is the equity graph when we go-long at every Death Cross and exiting our trade when the Golden Cross appears.

Interesting! At times going long actually makes money and notice how the equity graph spends a lot of its time above the zero line. Furthermore, unlike shorting the Death Cross, going long actually produces a positive result. Not much of a result but the equity graph does end in positive territory. Counter intuitive to common knowledge, I would say. Yet, it’s not much of a profit for all those years of trading and it’s certainly not an edge we can take advantage of. All in all this strategy is a wash much like shorting the Death Cross. This graph probably reflects the fact that the S&P 500 has had a bullish bias since 1961.

The equity graph also shows that during those periods imminently after a Death Cross and before a Golden Cross we have continued market weakness. In other words, not many market gains take place when the 50-period SMA is below the 200-day SMA. In general, this appears to be a time of market weakness.

Let’s take a quick look at the drawdown one would have to endure with this type of strategy.

Not as bad as shorting, but there are two spikes of 50%. There is also plenty of time spent around the 20% drawdown mark. That’s still some ugly drawdown that would be very painful to endure.

Going Long The Golden Cross

Next let’s look at going long the Golden Cross and Exiting on on the Death Cross.  Below is the equity graph.

This is a much improved equity graph! We seem to have a clear edge going long the S&P cash index when a Golden Cross is triggered. This graph highlights the fact that when the 50-period SMA is above the 200-day SMA the market often exhibits strong bullish behavior. Below is the drawdown experienced by this system.

Here drawdown is limited to a maximum of around 12%. This is a massive improvement from our previous signals we looked at. A 12% drawdown is much more tolerable. Clearly when a Golden Cross shows up it appears to be the “all-clear” sign in terms of both reward and risk. That is, we see substation market gains and low drawdown.

Summary

Combining what we have now learned I would say it might be wise moving your investing accounts into cash when a Death Cross takes place. This would be done in my opinion to prevent drawdown and thus avoid the pain seeing your profits evaporate. After a Death Cross drawdowns over 50% can take place and we see the upside is limited. It’s certainly can be much more psychologically appealing to be in cash when those big bear markets hit. Shorting a Death Cross does not have much of an edge and you often see massive drawdown with little profit as well.  It’s only after a Golden Cross does the market hold a strong bullish edge.

The table below shows the performance of each system.

By comparing the market behavior during a Death Cross vs a Golden Cross we can come to some generalizations that might help in both your investing accounts as well as your trading accounts (depending upon your timeframe). Of course the results of this article are based upon the S&P cash index, not individual ETFs or stocks. Thus the results could be generalized for a broad U.S. tradable index like SPY. Of course, you must do your own testing!

Death Cross = Move To Cash: During this time the market shows general weakness to the upside. This weakness can be difficult to short and drawdowns can be very substantial.  Moving into cash during this time may prevent you from experiencing these significant drawdowns. Remember, we are not talking about day trading in this article. The Death Cross and Golden Cross are based upon slow moving averages that work best for long term holding periods. A skilled day trader can make a lot of money shorting during a bear market, of course. However, when it comes to using a slow timing method such as the Death Cross, it does not seem to pay off.

Golden Cross = Invest: Upon a Golden Cross signal the market has demonstrated a lot of bullish activity with low drawdown. It appears to be the “all clear” signal to enter the market once again. When a Golden Cross occurs, we should be looking to go long.