Debating the merits of technical traders’ ‘death cross’ seems about as dangerous as debating the merits of gold right now, especially since the S&P500 just formed a feared death cross, as shown to the right.
As a quick background, a ‘death cross’ happens when a chart’s 50-day moving average drops below the 200-day moving average.
Many consider it a reason to be bearish right now towards U.S. equities, with even CNBC picking up the story.
Problem is, there’s no proof that a death cross even means anything for the broad market:
It turns out that the death cross has had a mediocre track record at best over the last two decades. To be sure, it’s had some great recent successes — such as the one that occurred in December 2007, very early in the 2007-2009 bear market. But there have been a number of other failures — such as one that occurred in October 2005, in the middle of the 2002-2007 bull market.
Overall, in fact, there has been no statistically significant difference since 1990 between the average performance following death crosses and all other market sessions.
Blake LeBaron, a finance professor at Brandeis University who has extensively analysed various technical analysis strategies including moving averages, says that what’s happened since 1990 raises the distinct possibility that something has permanently changed in the financial markets that largely eliminated moving averages’ potential as a market timing indicator.
Does this mean an end for the death cross? Of course not, or at least not until horoscopes and tarot cards disappear from the U.S.. Plus, any decline will likely be attributed to the cross by its most fervent believers while many critics, who may be right, will lose money for not ‘following it’. That’s the beauty of stock markets and we wouldn’t want it any other way.
(Tip via Abnormal Returns)