What’s going to happen to stock market prices? If we knew that, we could be very rich! Nevertheless, financial analysts constantly try to predict the movements of shares in order to decide when to buy and when to sell. One thing they do is to look at charts of price movements and look for patterns. These ‘chartists’, as they are sometimes called, refer to something known as the ‘death cross’ or ‘dark cross’.
So what is the death cross? Imagine a chart of the movements of share prices, such as the FTSE 100 in the UK or the Dow Jones Industrial Average and S&P 500 in the USA. These movements can be shown as a moving average. In other words, for each day you plot the average of the past so many days. Typically, 200-day (sometimes 100-day) and 50-day moving averages are plotted. The 200-day (or 100-day) is taken as the long-term moving average and the 50-day as the short-term moving average. In a falling market, if the short-term moving average crosses below the long-term moving average, this is called the ‘death cross‘ as it signifies growing downward pressure in the market. The fall in the long-term average in these circumstances will indeed lag behind the fall in the short-term moving average.
Markets around the world are experiencing the death cross. So should be be worried? Or is this like looking for patterns in tea leaves, or the stars, and using them to make bogus predictions? So: science or mumbo jumbo?
First the science: the death cross indicates a fall in confidence. And at present, there is much for investors to worry about. Burgeoning debts, austerity measures and fears of a double-dip recession are spooking markets.
Now the mumbo jumbo. Just because markets are falling at the moment, this does not prove that they will go on falling. Markets are often spooked, only to recover when ‘sanity’ returns. People may soon start to believe that a second credit crunch will not return, given all the regulatory and support measures put in place, the huge amount of liquidity waiting to be invested and the support packages from the ECB and IMF for Greece and, potentially, for other eurozone countries having difficulties servicing their debts. In other words, patterns may repeat themselves, but not necessarily. It depends on circumstances.
Articles
Market’s Swoon Prompts Fears Of the Dreaded ‘Death Cross’ CNBC, Jeff Cox (1/7/10)
Death Cross in S&P 500 May Not Lead to Rout: Technical Analysis Bloomberg Businessweek, Alexis Xydias (30/6/10)
Are the markets about to encounter the”Death Cross”? BBC News, Jamie Robertson (1/7/10)
MarketBeat Q&A: Debunking the ‘Death Cross’ Wall Street Journal blogs, Matt Phillips (30/6/10)
Technical analysis and market data
Moving Average Crossovers TradingDay.com, Alan Farley
Death Cross Investopedia
FTSE 100 historical prices Yahoo Finance
S&P 500 historical prices Yahoo Finance
Dow Jones historical prices Yahoo Finance
Questions
- Explain what is meant by the death cross and use a diagram to illustrate it. What is menat by the golden cross. Again, use a diagram to illustrate it.
- Under what circumstances would speculation against stock market price movements be (a) stabilising and (b) destabilising?
- What is the implication for stock market prices of a ‘wall of money’?
- How much faith should be put in chartist explanations of stock market prices? Do criticisms of chartism apply to all time-series analysis that is used for forecasting?
- Look back at newspaper articles from a year ago and see what they were predicting about stock market prices. Have their preductions been borne out? If so, why? If not, why not?