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SharePlanner (< 20)

The Death Cross: Is It Credible?

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July 28, 2010 – Comments (6)

Much has been made of the recent 50-day moving average that crossed below the 200-day moving average on the S&P. Among individual stocks, when the 50/200 cross occurs to the downside, many traders take it as a sign to get out of the stock immediately, or to start a new short position. With that being said, and the failed attempt, to-date by the bears to drive this market lower in the wake of a the 50/200 death cross, I asked myself, is this even a legitimate phenomenon that we should be paying attention to? Is there a legitimate play that we can take advantage of when this death cross comes about? So I decided to run some tests on my own and here is what I found. 

For my testing I looked at all the stocks in the S&P 500 over the past five years - let me just say that if there hasn't been a correlation in the past five years, is it really worth trading? So let's begin.

Here are the results for when any stock in the S&P 500 experienced the death cross and the subsequent results over the next month brought as a result (had you shorted the stock when the death cross occurred). As you can see not all that exciting at all.

(Sorry in advance for not posting the results - can't post .png files on MF for some reason)

Results

So maybe there is the slightest edge there, but not enough, in my opinion, to warrant any statistical significance. By the time you are done with commissions and SEC fees and such, there's probably nothing but a nasty loss staring you in the face.

But perhaps I wasn't giving the death cross enough of an opportunity to do something with these stocks, and maybe I should expand my time horizon to 3 months instead - so that is what I did, and here are the results had I shorted the stocks during the 3 month time period.

Results

Once again not all that impressive. In fact, the results are pretty much the same, except there are a few open positions still out there, that haven't been accounted for since they are still in the 3-month window, which is the reason for the difference in total trades (but none of those trades would alter the findings).

So Then I took the inverse of the trades, and looked at what it was when you BOUGHT the stock on the 50/200 death cross and SURPRISE! The results were the inverse of shorting the stock, but clearly unprofitable, just like short trade was. But what obviously stuck out to me is the fact that 54% of the trades were correct. Same goes goes for the 3-month Buy Signal. 

Results

Hold for 3 Months

Results

And this time you have an even better winning percentage (55%) and a slightly better gain/loss ratio. Which made me ask myself, "What if I put a little risk management in the equation and simply added a trailing stop-loss of 10% - what would my results be?" (assuming I could prevent some of those big 50% and 60% losers).

And here are the results...

Results

And LOOK AT WHAT YOU HAVE HERE! A profitable trading system (on paper). The winning percentage falls quite a bit, (from a best case of 55% on a 3 month hold to 44% with a trailing-stop), but for every dollar lost, you earn $1.90. Not bad at all! - And that is with BUYING any stock on the S&P 500 that has a 50/200 death cross, but also putting on a 10% trailing stop-loss on every trade.

Finally, what happens when you SHORT any stock on the S&P 500 when the 50/200 death cross occurs to the downside? Your results are not much different had you just held it for one month or three months. But your winning percentage also drops dramatically (down to 35%).

Results

So what can we conclude from this? That the death cross that has become a "Sell-Sign" for many traders is nothing more than statistically insignificant, if not downright dangerous to trade off of. You will do yourself a lot of good, if you just ignore the death cross when it happens in individual stocks, as there is no merit to it at all.

6 Comments – Post Your Own

#1) On July 28, 2010 at 4:06 PM, Griffin416 (99.98) wrote:

If you look at the DOW over the last Hundred years, you will find  more often than not, stocks drop significantly after the death cross. Stocks also gain even more often than not after a golden cross with a larger gain than a loss during the death cross.

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#2) On July 28, 2010 at 4:21 PM, SharePlanner (< 20) wrote:

I don't doubt that you're right...but over the past 5 years, on individual stocks, there hasn't been much to write home about. Also, many times when enough people are watching and acting on the same thing, th results become muted, and that could be what has happened with the death cross as well.

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#3) On July 28, 2010 at 4:28 PM, davejh23 (< 20) wrote:

This is an interesting look at the usefulness of the "death cross" for individual stocks.  Thank you.  It's still worrisome that stocks have fallen 40%+ 2 of the last 4 times we saw a "death cross" on the S&P.  As for the most recent cross, we'll have to wait and see.  Looking at statistics, there's a high probability that the market heads much lower following an S&P "death cross" if the spread between the 50-day and 200-day widens beyond where it is right now.  If the market heads higher short-term, the cross will likely reverse in another month or so, just like 2004 and 2006.  If the market heads lower here, I wouldn't bet against a major decline...market action over the next couple weeks could be telling.

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#4) On July 28, 2010 at 4:32 PM, awallejr (79.45) wrote:

Interesting blog.  Your time frame seems a little short. 100 years is meaningless to me since you are mixing apples and oranges.  But a 20 year time frame would be interesting to test.

+rec.

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#5) On July 28, 2010 at 4:39 PM, Dobbes (< 20) wrote:

Enjoyed the post.  What software did you use?

You can also embed images with html in blog posts.  Here's a quick tutorial: http://www.htmlclinic.com/images.php

 

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#6) On July 28, 2010 at 4:40 PM, davejh23 (< 20) wrote:

I guess you could say that "death crosses" formed at the tail end of a bubble are good indicators of a crash.  The question is, was the rally over the last year a bubble?

 

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