How To Trade A Death Cross...
The Dynamic Wealth Report
July 2, 2010
by Corey Williams, Editor
The Death Cross… It’s one of the most ominous sounding technical
analysis signals. But what is it, and more importantly, is it any good at
predicting future stock price movements?
Let’s take it from the top.
A Death Cross is a bearish chart pattern. In the world of technical
analysis, it’s seen as a sign of more losses to come.
It’s formed when the 50-day moving average crosses below the 200-day
moving average of a stock or index. In plain English, it means the recent
average price has fallen below the long term average price.
It’s a fairly rare event for a Death Cross to appear on the S&P 500. It’s only happened four times in the last ten years. But we’re about to
get another one… and it’s got technical analysts buzzing.
Take a look at this chart of the S&P 500. You can clearly see the 50-day
moving average (solid line) descending toward the 200-day moving average
(dashed line). When the lines cross, the Death Cross pattern has been
formed…
Does a Death Cross mean we’re destined to see much lower prices?
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Despite the scary name, a Death Cross is really bad at predicting future
price movements. Let’s take a look at how the S&P fared one month after
the previous four Death Crosses.
December 21st, 2007 was the most recent Death Cross. One month later the
S&P 500 was down 11.72%.
Before that we had a Death Cross on July 19th, 2006. One month later the
S&P 500 was up 2.99%.
We saw another one back on was August 18th, 2004. One month later the
S&P 500 was up 2.47%.
Back on October 31st, 2000 we had yet another Death Cross. One month
later the S&P 500 was down 8%.
As you can see, a Death Cross is pretty useless. It’s one technical
signal I don’t put much stock in. And neither should you…
It’s just as likely to mark the end of a market correction as it is to
indicate the beginning of a new bear market.
Here’s what I am paying attention to.
The S&P 500 and the NASDAQ have both formed a head and shoulders
pattern. It’s a chart pattern indicating the bull market since March of
2009 is over.
But you need to be careful with reversal patterns. Just because the bull
market’s over doesn’t mean a new bear has begun. It only means the
previous bull is over.
Investors new to technical analysis often get this analysis wrong. So
let me say it again… When a trend ends with a reversal pattern, it
doesn’t mean a new trend in the opposite direction has formed. This is
an important difference. Don’t make a rookie mistake and assume we’re in
a new bear market just because the previous bull is over. (We could see
another bull market shortly.)
Right now the future is a bit unclear according to the charts. We’ll
likely see the markets move lower in the very short term.
But anything could happen. We could see a period of sideways or range
bound trading. We could also enter a new bull market. Or we could enter
a bear market. (We have to wait and see what the market gives us.)
The point is the end of a bull market doesn’t mean were destined to
enter into a bear market. And the formation of a Death Cross on the S&P
500 doesn’t mean a new bear market has begun.
If you’re a long term investor, use the dips to build positions in your
favorite dividend paying blue chip stocks. And if you’re a trader, take
profits quickly. And for your own good, don’t pay any attention to the
Death Cross…
• BJ’s Wholesale Club (BJ) was upgraded by
Jefferies this week. They now have a buy rating on the stock. Green
Equity Investors took a 9.5% stake in the company and is in talks with
management to take the wholesale warehouse club private.
• Fuel Systems Solutions (FSYS) was downgraded to
underperform by Northland Securities this week. Investors have a 54%
short interest in the maker of alternative fuel components and systems.
• Stifel Nicolaus started coverage on Apollo Group
(APOL) this week with a buy rating. The for-profit education company’s
stock has fallen 36% since its April high.
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