The Death Cross
On Friday (07/02) the S&P 500 made a “Death Cross”.
This ominous-sounding event occurs when the 50-day moving average crosses under the 200-day, and to some technicians it signals the start of a long-term bearish bias.
In this post I’ll put the Death Cross to the test and compare it to its bullish cousin, the Golden Cross.
The graph above shows the results of going long the S&P 500 following a Death Cross (red, 50-day SMA < 200-day SMA) versus the Golden Cross (green, 50-day > 200-day) from 1930. I’m assuming the investor traded at the close on the day of the cross.
Geek note: see end of post for assumptions about return on cash and trade frictions.
The graph appears to show that the market has been far less bullish following a Death Cross. But to be fair, the graph isn’t really comparing apples to apples because the market has spent so much more time in a Golden than a Death Cross (64% vs 36% of all days), so let’s look at the numbers…
The numbers confirm that while the market has eked out some small gains following the Death Cross, it has also exhibited far more downside risk (see drawdown) and been far less bullish on days invested (see daily return vs volatility).
The moral of the story is twofold:
1. The market has clearly exhibited weakness following a Death Cross, and investors of the longer-term variety should take heed. However…
2. That weakness has not (in and of itself) justified shorting the market. The market has still on average gained following a Death Cross, and without other confirming signals, long-term investors are better off simply moving to cash.
[Click for a summary of our posts related to the Golden Cross]
Side note: some interpretations require that the 50 and/or 200-day MA be falling to call a Death Cross. This additional rule increases the bearishness of the Death Cross, but also greatly reduces the number of days that qualify as a Death Cross.
Test assumptions: (a) I’ve calculated the moving averages using the S&P 500 cash index (which investors generally use), but calculated returns based on daily dividend-adjusted data (dividends interpolated from quarterly data), (b) results frictionless (i.e. do not account for transaction costs/slippage) but could be closely reproduced in today’s market using mutual funds less part of an annual expense ratio, and (c) I have not accounted for return on cash.
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Filed under: Trading Strategies, Trend-Following | 21 Comments