The Death Cross - How To Trade It

In this article I'm going to show you some ideas on how you can use the Death Cross and the Golden Cross in your personal trading. By the end of this article you'll see the Death Cross and Golden Cross can be an important event to watch for. The ideas presented in this article can be used for standard brokerage accounts when trading stocks or ETFs. It can also be used in retirement accounts such as IRAs and 401Ks. The concept behind following this signal is to warn you upcoming market weakness or market strength. Using this important signal may help you generate more gains and more importantly, keep those gains!

The Death Cross is simply when a 50-period simple moving average (SMA) crosses under a 200-period SMA on a daily chart. Such a signal is believed to warn of upcoming bearish market activity. The opposite signal is called a "Golden Cross" and is alleged to warn of bullish market activity. But does the Death Cross or the Golden Cross hold any merit? Using TradeStation's EasyLanguage coding language it's simple to create a trading system that is always in the market switching between a long position and a short position based upon a moving average crossover. Here is what the entire trading system code looks like:

if ( verage(Close,50) crosses above Average (Close,200) ) then buy ("Golden Cross") next bar at open; if ( Average(Close,50) crosses under Average (Close,200) ) then Sell short ("Death Cross") next bar at open;

In order to get a long-term feel for this system I'm going to use the S&P500 index going back to 1961. The trading system will have an initial trading account size of $20,000. To keep the position sizing simple each signal will use $10,000 to determine the number of shares to purchase. By dedicating $10,000 to each trade we are attempting to normalize the number of shares we purchase based upon the cost per share. Back in the 1960s one share was around $70 while today it's worth over $1,000.

Next, I opened a chart with daily data for the S&P E-mini from 1961 to September 30, 2011. I then applied the strategy to the chart while making no deductions for commissions and slippage.

Before we start looking at some of the numbers I want to break this study into two parts: Shorting a Death Cross vs. going long the Golden Cross. What interests me is how well the system functions going long vs going short. In other words, what does the SMA cross tell us about a bearish cross vs a bullish cross? Are they different?

Shorting The Death Cross

Net Profit: -$1,000

To simply short the Death Cross may not be very profitable. There is nothing in this picture that suggests we have an edge simply shorting the S&P index upon a Death Cross signal. Maybe we should be taking the Death Cross as a buying opportunity? Why not? We want to be opposite the crowd, right? Below is the equity graph when we go-long at every Death Cross.

Going Long The Death Cross

Net Profit: $1,000

Interesting! Unlike shorting the Death Cross, going long actually produces a positive result. Counter intuitive to common knowledge, I would say. Yet, it's not much of a profit for all those years of trading and it's certainly not an edge we can take advantage of. All in all this strategy is a wash much like shorting the Death Cross.

Going Long The Golden Cross

Net Profit: $39,000

This is a much improved net profit! We seem to have a clear edge going long the S&P 500 when a Golden Cross is triggered.

Summary

Combining what we have now learned I would say moving your investing accounts into cash when a Death Cross forms may be a good idea. This would be done in my opinion to prevent drawdown and thus avoid the pain seeing your profits evaporate. It's certainly can be much more psychologically appealing to be in cash when those big bear markets hit. Shorting a Death Cross does not have much of an edge and only after a Golden Cross does the market hold a strong bullish edge.

Upon a Death Cross signal the market shows general weakness to the upside. This weakness can be difficult to short. Moving into cash during this time may prevent you from experiencing significant drawdowns.

Upon a Golden Cross signal the market has demonstrated a lot of bullish activity. This one is easy. When a Golden Cross occurs, going long the market may lead to strong gains over the coming months and years. This is when you should be in the market.

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