What Is a Death Cross in Stocks and Should You Worry?

So you might have heard the term "death cross" floating around in the news or among your investor friends, and it sounds pretty scary, right? Well, in the world of stock market analysis, a death cross in stocks refers to a specific pattern that shows up on a stock chart.

What Is a Death Cross in Stocks? A Basic Definition

Simply put, it's when a shorter-term moving average of a stock's price drops below its longer-term moving average. Think of it like a weather forecast where one trend line crosses below another, signaling a potential shift in the market's direction.

The most common moving averages people watch are the 50-day moving average (representing the average closing price over the last couple of months) and the 200-day moving average (representing the average closing price over a longer period).

How Does a Death Cross in Stocks Occur?

To understand how a death cross in stocks occurs, let's break down those moving averages a bit more…

A moving average essentially smooths out the daily price fluctuations of a stock, giving you a clearer picture of the overall trend over a specific period.

The 50-day moving average is more sensitive to recent price changes, while the 200-day moving average takes a longer view.

Now, let’s talk about how a death cross in stocks starts to form, because the death cross pattern takes shape over a few phases.

First, you typically have a stock or the broader market in an uptrend, where prices have generally been rising.

Eventually, this upward momentum starts to lose steam and buying interest begins to wane.

As sellers start to gain control, the stock price begins to fall.

This decline causes the more reactive 50-day moving average to start trending downward faster than the slower-moving 200-day average.

The crucial moment, and the actual "death cross," happens when that 50-day moving average crosses below the 200-day moving average.

This crossover is seen by many technical analysts as a signal that a new, bearish long-term trend might be taking hold.

The final stage, for a death cross to be considered genuine, is a sustained downward movement in the stock price or market. If the price quickly rebounds, the death cross might be seen as a "false signal."

Confirmation of a Death Cross in Stocks

While the crossover of the 50-day below the 200-day moving average defines a death cross in stocks, many technical traders look for additional clues to confirm the strength of this bearish signal…

One popular confirmation tool is trading volume: If the death cross occurs alongside high trading volumes, it suggests that more investors are participating in the selling, lending more weight to the idea of a major trend change.

Think of it like a crowd heading for the exits — more people moving indicates a stronger conviction in the change of direction.

Another way to potentially confirm a death cross is by using momentum indicators like the MACD (moving average convergence/divergence).

These indicators can help show if the downward momentum is indeed picking up steam.

The idea here is that the momentum of a long-term trend often starts to fade a bit before the market actually turns. So if momentum indicators are also showing a bearish shift around the time of the death cross, it can add to the conviction of the signal.

Historical Examples: What Is a Death Cross in Stocks and What Happened Next?

The death cross has earned its ominous name because some of its historical occurrences have indeed preceded significant market downturns.

Those who believe in its predictive power often point to instances like the death cross in the Dow Jones Industrial Average before the crash of 1929, the one in the S&P 500 Index in May of 2008, just months before the financial crisis, and the one in the Nasdaq as the dot-com bubble burst…

Other severe bear markets, such as in the ones 1938 and 1974, were also preceded by death crosses.

However, it's crucial to get a broader perspective on what is a death cross in stocks by looking at a wider range of historical examples…

Despite the scary name, market history actually suggests that a death cross often tends to be followed by a near-term rebound with above-average returns.

For example, according to Fundstrat research cited in Barron's, the S&P 500 index was higher a year after a death cross about two-thirds of the time, averaging a gain of 6.3% over that period.

While this isn't the exceptionally high annualized gain the S&P 500 has seen historically, it's certainly not a disaster.

Interestingly, the track record of the death cross as a precursor to market gains looks even better over shorter time frames, in some cases…

Nautilus Research found that the 22 instances where the 50-day moving average of the Nasdaq Composite fell below its 200-day moving average between 1971 and 2022 were followed by average returns of about 2.6% in the next month, 7.2% in three months, and 12.4% six months after the death cross.

These returns were roughly double the typical Nasdaq return over those time frames.

Recent history also provides some interesting examples…

A death cross occurred on the S&P 500 in December 2018, which led to some initial losses, but the index then rallied strongly and was well above its death cross level within six months.

Similarly, another S&P 500 death cross during the initial COVID-19 panic in March 2020 was followed by significant gains, with the index up over 50% in the next year.

Even the death cross in the S&P 500 in March 2022, when the Federal Reserve started raising interest rates, saw the index higher a year later.

While there was some initial pain, the long-term outcome has often been a positive one.

The Death Cross in Stocks: A Lagging Indicator

It's important to understand that a death cross in stocks is often considered a lagging indicator.

This means that the signal appears after a significant amount of price action has already occurred.

By the time the 50-day moving average crosses below the 200-day moving average, the stock's price has likely already experienced a substantial decline.

As ChartSmarter founder and market technician Douglas Busch puts it, "Death crosses often occur after most of the technical damage has been done," calling it a "kind of rearview mirror reflection."

Fairlead Strategies founder and market technical Katie Stockton agrees, stating that the death cross is a "lagging indicator" and "isn’t a reliable device for timing the market."

This is a crucial point for investors to remember…

Relying solely on the death cross to make investment decisions can be problematic because it doesn't necessarily tell you what's going to happen next, only what has already happened in terms of price trends.

Some analysts even use a variation of the death cross where they look for the security's price itself to fall below the 200-day moving average, as this often happens before the 50-day moving average crossover.

This highlights the lagging nature of the traditional death cross. Because it's based on past price averages, it can be slow to react to a sudden change in market sentiment or fundamentals.

Putting Worry Aside About This Recent Death Cross in Stocks

Simply put, the death cross in stocks isn’t necessarily something you need to fear…

It's a chart pattern that occurs when the 50-day moving average crosses below the 200-day moving average. And it’s seen by some as a bearish signal indicating potential market weakness.

While its ominous name and historical association with some major downturns can be concerning, it's essential to remember that history also shows that the majority of the time, stocks tend to be higher within a year after a death cross occurs.

Experts like Douglas Busch and Katie Stockton emphasize that the death cross is often a lagging indicator and not a reliable tool for predicting future market movements.

So if you hear a lot of panic about a death cross in the market, take a deep breath…

While it's a signal worth noting in the context of broader market analysis, it's not necessarily a reason to panic and sell all your stocks.

In fact, considering the historical tendency for markets to rebound and generate gains after a death cross, it likely represents more of a buying opportunity for long-term investors than a definitive sell warning.

So keep a long-term perspective, remember that markets have a general upward bias, and don't let the scary-sounding name of the death cross lead to rash decisions.

Instead, consider it as one piece of the puzzle in understanding market trends, but certainly not the only, or even the most important, piece.

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