Dow Jones Death Cross 101

How Investors Should React

Dow Jones Death Cross 101
September 3, 2015

"The Death Cross" sounds like a bad horror movie. Some on Wall Street believe that it's a precursor to a real-life horror show, starring your stock portfolio as Hapless Victim #1. Others believe that it's a mindless exercise in chart watching. Brett Arends of MarketWatch called recent death cross concerns "pure voodoo."

What is a death cross, and why are people so concerned about its effect?

A death cross occurs when a long-term moving average of a particular stock or an index falls below a shorter-term moving average. Typically this refers to the 50-day and 200-day moving averages. By definition, it indicates an intermediate-term downward trend. The big question is whether it is a precursor of a prolonged bear market, or even a crash.

The Dow Jones Industrial Average experienced a death cross last week, prompting speculation that the long-predicted bear market may be near. Pessimists pointed to the fact that the Dow Jones Transportation Index and the NYSE Composite also experienced a recent death cross and that the S&P 500 is extremely close to one (as of this writing). If multiple indices are falling, how can it not be a bad sign?

Others look at the death cross as no better than a coin flip as a predictor for a major downturn. Bespoke Investment Group looked over the past 100 years and concluded that the Dow tends to bounce back after a death cross "more often than not." In the short term, there is a modest downturn, as there almost has to be from the basic math of averages. The downturn averages 0.17% in the next month after the death cross and 1.52% three months after the cross — hardly a reliable harbinger of a bear market.

There have been four recent death crosses before this one: 2004, 2008, 2010, and 2011. Only one of those was associated with a bear market. There are more death crosses than bear markets. It is worth pointing out that the one bear was a big one, with over a 50% drop in the Dow after the January 2008 death cross. Recent drops have been significant such as the almost 6% drop six weeks after the July 2010 death cross. It may not be a bear market, but losses were significant.

One popular indicator is to discount the death cross unless both the 50-day and 200-day averages are sinking as the crossover takes place. The premise is that if both short and long-term trends are down, a bear must be coming. However, the sinking 200-day average premise did not predict the 2008 bear market. Bear markets are often the result of valuation bubbles popping in rapid fashion, where trend analysis is actually counterproductive.

The significance of the death cross may have changed with increased daily market volatility. Moving averages act as a smoothing factor to spot the truly long-term trends. The more days that are averaged, the greater the smoothing effect. Perhaps in the future something like a comparison of a 300-day vs. 100-day average would be more meaningful.

As an investor, should you flee the clutches of the death cross or laugh it off as mere nonsense? You should do neither. Treat it as what it is — a negative indicator amid many other complex factors. Look for the underlying reasons for the death cross and whether those reasons, combined with other factors, lead you to believe the market will continue to fall. Then, and only then, should you retreat from stocks and view the economic carnage from a safe distance.

Photo © mrak_hr

  Conversation   |   30 Comments

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Steffanie | 09.03.15 @ 15:05
Great information for those who are active in the stock market.
Chrisitna | 09.03.15 @ 15:06
What an interesting name! Watching to see what happens with the market to see if the name is accurate!
Erin | 09.03.15 @ 15:09
I've never heard this term before. Thanks for increasing my knowledge of the stock market.
Nancy | 09.03.15 @ 15:10
"Pure voodoo" with some basis of fact? We cannot foretell the future, even if Wall Street wants to. Their powerful reach hasn't extended that far.
Meredith L | 09.03.15 @ 15:12
I tend to think of this as something of a hocus pocus way for media to scare us into volatile action. That being said, if you have a good broker/financial advisor, they will almost always tell you to stay the course and remain calm.
Kamie | 09.03.15 @ 15:20
That is a lot of things I did not know.
Britt | 09.03.15 @ 15:21
Lots of great information and a rather interesting name.
Sarah | 09.03.15 @ 15:29
I still think it'd make a great horror movie name....
Jackie | 09.03.15 @ 15:29
What an interesting term. I wonder just how many investors know the term.
Wanda Langley | 09.03.15 @ 15:43
Great info for people who invest in the Stock Markets. Will watch the Market and see how it comes out.
Carla | 09.03.15 @ 15:48
I can only imagine what those that invest a lot of money go through when they see this death cross. The anxiety levels must go through the roof!
irene | 09.03.15 @ 15:50
What a scary name! Good information.
Crystal | 09.03.15 @ 16:08
Interesting read and name.
Elaine | 09.03.15 @ 16:09
Love the catchy title. Again, some great info here in this article.
Beverly | 09.03.15 @ 16:21
My husband follows the market and he was talking about the death cross last week. It will be interesting to see if the market actually follows a trend it is supposed to.
Alec | 09.03.15 @ 16:29
That would be a good horror movie title. It sounds really scary, but seems to be more of a "jump scare" than an actual scare in terms of what it means for the stock market. It sounds to me like people make it a self fulfilling prophecy though, based on some of the other articles posted. Specifically the one that mentions the stock market is also psychological. If enough people get scared by it and dump stocks, they're practically forcing it to happen.
trish | 09.03.15 @ 16:31
Well, that would definitely get my attention if I saw that!
gracie | 09.03.15 @ 16:57
Everyone is watching the market with their breath held. Panic creates a fall, yet if you don't pull out in time there is a lot on the line to loose.
Jill | 09.03.15 @ 17:00
What a great read. Wish I knew more about the stock market!
Morgan | 09.03.15 @ 17:02
This is the first time I have ever heard this term, but it does seem rather interesting.
Chelsey | 09.03.15 @ 17:03
And this is why I want to get a financial advisor. So many terms, so many things to watch for, definetly a full time job.
Heather | 09.03.15 @ 17:24
I have never heard about this before. Very interesting article. You learn something new every day!
STOKES | 09.03.15 @ 17:31
I've never heard of this before, but it makes sense!
Rindy | 09.03.15 @ 17:32
I don't know much about the stock market, but am trying to learn more. Thanks for the great information.
Sara | 09.03.15 @ 17:35
There is a lot I did not know. However, I am kind of glad I am not into trading stocks. I never understood it and was always scared to do it.
Daniel | 09.03.15 @ 17:38
That is one hardcore name ... but interesting info as well. Learning more about the market is great.
Zanna | 09.03.15 @ 17:47
That sounds like such a dire term, but the information in the final paragraph really sums it up - look for the underlying reasons and evaluate the situation carefully, rather than reacting to a term that may or may not be relevant to how the current market runs.
Jo Ann | 09.03.15 @ 17:52
This article was written for someone who really understands the stock market. It would have been a lot less confusing if they had just said watch the averages of stocks, it it goes down a significant amount over the course of 200 days it is a sign or trend to take notice of.
Rychana | 09.03.15 @ 17:56
I don't follow the stock market, but this a great article.
Kate | 09.04.15 @ 10:11
Interesting. Will be watching to see if this comes to pass, and if it does, this makes you wonder what can be done to right it.
$commenter.renderDisplayableName() | 01.17.21 @ 15:47