Finance 0

Death Cross Indicator For S&P 500 Not As Reliable As Most Perceive

By Kurt Osterberg · On May 22, 2016

The Death Cross, whereby the 50-moving average crosses under a moving average of 100 or 200, occurred recently in a weekly time frame for the S&P 500. The subject has raised some concerns amongst investors as financial media pundits emphasized that it has occurred only twice in the previous 16 years. One occasion marked the onset of the Great Tech Wreck in 2001 and the other ushered in the Great 2008 Recession. The inference is that because both preceded some of the worst carnage of capital destruction experienced in investment history, the reemergence of this pattern indicates a high probability or almost guarantee that another bear market is imminent.

However, the reality is that these last two financial crashes were so severe that their ghosts continue to haunt the market. Completely ignoring this indicator is not wise, but neither is believing Chicken Little financial media pundits frantically running around and screaming “the sky is falling “. Before dismantling the myth of the Death Cross and reconstructing it within a proper context, let me state, as a proponent of technical analysis, that even I raise an eyebrow when I see this crossover. Now, in true Hillbent fashion, shall we begin?

Expand historical data and sampling: If the market is basing perceptions on probabilities, then due diligence requires a larger sampling of data to quantify the validity of such assumptions. Instead of analyzing only 16 years of history, let’s review the last 86 years or so of weekly market data for the S&P 500, which spans from 1930 to the present. (That sounds fair enough to me, but if you disagree, please feel free to share your comments explaining why.)

Include inverse indicator for more complete analysis: Next, if investment outlooks and decisions are being made upon the Death Cross indicator, then by default one must accept its inverse indicator, i.e. the Golden Cross (which is when the 50 period moving average crosses above the 100 or 200 period moving average and signals a shift to a bullish market trend). After all, you can’t just use the indicator for part of the time and then arbitrarily abandon it before it changes. (Well, actually you can and, by doing so, just realize that you are no longer using the indicator, but something else.)