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Death Cross Bearish Technical Indicator

Posted By Jim On 08/29/2012 @ 7:15 am In Investing | 2 Comments

As you all probably know, I think technical indicators are often self-fulfilling prophecies. If a lot of traders, especially high frequency traders, think that an indicator works, then they’ll make trades when they see the indicator. If enough of them do it, as is the case when it’s all computers, then the indicators work more often than they don’t. If all signs point to buy and lots of people buy, then the stock goes up and we can look back and say that the indicator worked.

Bearish indicators will lead them to sell. Bullish indicators will lead them to buy. When they look back at how their trades performed against the indicator, they’ll be validated as long enough other traders join them. These traders do a lot of trading, so just a few ticks upward means a profit to them and they just need to be right more often than they’re wrong.

Most technical indicators have boring names, like cup and handle [3], but I discovered one that actually has an interesting name – it’s called the DEATH CROSS. (it’s made more ominous because I put it in all caps and I bolded it!)

What is a Death Cross?

A death cross is when a shorter moving average crosses a longer one. Here’s the S&P 500 [4] during the last six months (click to enlarge):

The green line is a 50 day simple moving average and the red line is a 100 day simple moving average. You see how they crossed in early June? The idea is that the short term prospects of the index are weak, hence the dipping 50 day SMA, and so it drags down the longer moving average. The end result is that the moving averages act as a higher bound on the index, or stock, and it all drifts lower.

I purposely chose one where the technical indicator was wrong (or late to the party anyway, the dip from that last peak in early May to the lower trough in early June was over 100 points) just to illustrate that these things are hardly perfect. In fact, I’d imagine technical indicators give you just a slight edge if you have the ability to identify them accurately and enough capital to seize those opportunities frequently enough.

I still like the name though.

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[3] cup and handle: http://www.bargaineering.com/articles/technical-indicator-cup-handle.html

[4] S&P 500: https://www.google.com/finance?q=INDEXSP%3A.INX

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