Be very careful when you see a "death cross" chart pattern. The emergence of a death cross confirms the long-term stock price reversal. It is a strong indicator of the potential bear market.
Death cross chart pattern is especially useful for trading growth stocks that have been rising for a prolonged period of time. Due to their rapid business growth and steady stock price appreciation, many people have become big fans of these growth stocks. They are emotionally attached to them and have lost their vigilance about the big risk - a potential stock price crash. They believe that these stocks will rise again no matter how much they fall. Unfortunately, business growth will eventually slow down, and company's fundamentals can quietly deteriorate without retail investors even noticing (example: Netflix in 2022). The death cross can help us to identify the potential trend reversal earlier and to avoid huge investment losses.
PLTR, a Big Data analytics software provider in the Silicon Valley, was the former darling of venture capital and retail stock investors. Its stock price shot up to as much as $45 a share shortly after IPO. But since a death cross formed in early December 2021, it has dropped more than 50%. See chart below.
These big investment losses can be avoided as long as you have a little understanding of the death cross chart pattern. Experienced and daring investors can even make huge profits by shorting these death-crossed stocks!
So, what is a Death Cross Chart Pattern？
A classic death cross chart pattern is defined as:
1) the 50-day moving average drops below the 200-day moving average.
2) the 200-day moving average line must be trending down at the crossover.
Note that in many cases, even if the 200-day moving average line is trending horizontal or slightly upwards when it crosses, if the downward momentum is strong enough, it can pull the 200-day moving average downwards soon after the crossover. This kind of crossover should be monitored closely and analyzed in combination with other indicators. If the upward 200-day moving average begins to trend down shortly after the crossover, the crossover still qualifies as a "death cross".
NFLX formed a death cross in early February 2022. Before the death crossover, the stock had already fell a staggering 50% from its top. Since death crossover, it dropped another 50%!
However, if the 200-day moving average is in a steep, apparent uptrend when it crosses, the crossover is not considered a "death cross" and cannot indicate any direction. In this situation, even if the short-term trend is bearish, due to the strong support from the rising 200-day moving average, the stock price will often be pulled back to the rising channel. This type of crossover can be very deceptive. Close attention is required.
The chart below shows a crossover formed by a 50-day moving average crossed below the 200-day moving average of iron ore mining stock CLF in mid-January 2022. Note that the 200-day moving average was in an apparent upward trend when it crossed, so it cannot be called a death cross. Although the stock price fell sharply following the crossover, it was quickly pulled up, breaking above the 50-day and 200-day moving average resistance levels in a row, back to a new upward trend! Note that the moving average crossover on the right-hand side of the chart is a standard golden cross. (Read my other blog about golden cross.)
A "perfect" death cross is when both the 50-day and 200-day moving averages are trending down when they cross.
The chart below shows a "perfect" death cross formed by SQ at the end of November 2021. Shares barely rebounded in the ensuing four-plus months, dropping more than 60% at most.
Why is Death Cross Chart Pattern Predictive?
By the time the death cross occurs, the stock price has fallen from its highs. Forming a death cross requires both the 50-day moving average and the 200-day moving average to be trending down at the same time. The 50-day moving average represents the medium-term trend, and the 200-day moving average represents the long-term trend. Both declines at the same time indicate that the stock is already in a downtrend in both the mid- and long term.
How to Make Use of the Death Cross for Trading?
You have better odds to make money by "sell the rally" instead of "buy the dip" for death-crossed stocks.
Death crosses occur more often on individual stocks than on stock market indices. Individual stocks have much faster bull/bear cycles. They can easily form a trend that lasts for a few months to a couple of years. But the broader market indices are tracking economic cycles which often span multiple years. Death cross chart pattern occurs at the beginning of every bear market. They are the early signals of bear markets.
Should you liquidate positions or go short immediately after seeing a death cross? Not really! First, like any other signals, the death cross signal is not 100% predictive. Sometimes it just sends a false alarm. You will need to decide if the death cross will be predictive by considering other data and signals, such as overall stock market valuation, economic cycle, investment sentiment, position to moving averages, overbought, events etc.
Second, like the golden cross, the death cross is a lagging signal. Due to the lagging effect of the moving averages, stock prices are often extremely oversold around the death crossover. There can be a rebound at any time (commonly known as the dead cat bounce). The dead cat bounce can be volatile. The best time for exit or short is when the stock price bounced to major resistance levels.
Mastering the Death Cross Chart Pattern Can Help You Find the Best Exit Points (or Short Opportunities) Before Major Stock Price Declines.
Before the emergence of a death cross, the stock price must have retreated from its all-time highs. The stock price must have dropped below the 50-day moving average already, indicating mid-term weakness. Eventually, the 50-day moving average will be trending down, the 200-day moving average will be flattening, and the two moving averages will start to converge. By this point, you should be able to anticipate an emerging death cross to rise in the near future and act ahead of time.
You will often see the phenomenon of lower highs and lower lows. Each rebound of stock price will be suppressed by the key resistance levels, such as the 50-day or 200-day moving averages, the trendline, or the previous lows or highs, etc.
The best exit point or take a short position is when a rally reaches but fails to break a major resistance level.
For example, PYPL, before the death cross was formed in October 2021, there were two excellent exit (or short) opportunities. These exit points are easy to identify as they are when the rebound failed to break a major resistance level. Seizing these opportunities and acting early can avoid subsequent 70% loss in the next 5 months.
Another example is SOFI, which fell directly below the 200-day moving average a month and a half before the death cross emerged, indicates that the long-term trend has turned bearish. This is a good exit point. Exit here can avoid the subsequent 60% loss. After the death cross was formed, each rebound of the stock price was blocked by the 50-day moving average or the 200-day moving average (some people also like to use the trend lines, which are similar). Once again, the good timing to go short or unload your long positions is when the stock bounces back to these resistance levels. See chart below.
Limitations of the Death Cross Chart Pattern
The Death Cross chart pattern is a quite reliable signal that indicates a continuing downtrend. However, like any other technical signal, the appearance of a death cross is no guarantee that the downtrend will continue. In this case, the stock price may have already bottomed out and a new upward trend may start, shortly after the death cross formation.
Moving averages are lagging indicators. Likewise, the Death Cross chart pattern is a lagging indicator. When a death cross is formed, the stock price is already in a downtrend. Big damages to portfolio might have already happened by the time the death cross occurs. To avoid such early (but can be devastating) losses, you can't wait for the death cross signal. Instead, you will have to use other top reversal signals such as candlestick reversal chart patterns, change in trading volume, position of stock price to the moving averages, etc.
Here's an example of a "perfect" death cross that the Dow Jones index formed in March 2020. But before the emergence of this death cross, the index has bottomed out, and a two-year super bull market started immediately. It can be seen that this death cross, even if it meets the strict definition of the death cross chart pattern, cannot accurately predict the future trend.
It is very risky to trade stocks based on just one technical indicator. The Death Cross is more reliable if used in conjunction with fundamental analysis and other technical signals such as trend lines, resistance levels, overbought & oversold signals, etc.
How to Find Stocks and ETFs with Death Cross Chart Patterns using the FinTurtle App?
The FinTurtle app scans more than 10,000 U.S. stocks twice a day to detect death cross chart patterns. You can use its "Death Cross" screener to find all stocks with death cross formation.
Follow the Step-by-Step Instructions and Illustrated Chart below:
- Open the FinTurtle App.
- Navigate to the Discover / Platinum / SMA 50/200 Death Cross feature tile and click to open.
- You will see the comprehensive screener interface. You may keep all default settings and click "Submit" at the bottom. The default setting is to display the stocks with the classic SMA50/200 Death Cross pattern formation. If you would like to view Death Crosses by other moving averages, or use other criteria to further filter the results, you can set the filters accordingly before clicking "Submit".
- You will find all the stocks that have formed a Death Cross over the past 2 weeks. The "Date" column shows when the SMA 50 crossed below the SMA 200.
- Touch any stock to view its fundamentals, charts, institutional holdings, insider trading and many other signals and insights.
(How to Find Stocks and ETFs with Death Cross Chart Patterns)
