In case you haven’t heard “US Small cap stocks just formed a death cross”. Eee gads. Kinda grabs your attention as it sounds ominous, doesn’t it? The name conjures up thoughts of October 1929. In technical analysis jargon a death cross is nothing more than when the 50-day moving average crosses under the 200-day average. Those trying to grab your attention in order to sell advertising just love names like death cross. Fear pays. Another one that comes to mind is the Hindenburg omen. Sell everything, run for cover and get into your bomb shelter we have had a number of recent Hindenburg sightings of late. There are, of course, others but I digress.
Why make news of the death cross? There are some people (those that must not care about probabilities) that use the death cross as a signal to sell their stocks. Like all things involved with TA, sometimes it works and sometimes it doesn’t. Either way … gotta have a plan and this is, well … at least a plan. As it turns out, not a statistically profitable one. A death cross on small cap stocks has not been historically threatening at all. In fact, it’s just the opposite. The good folks at quantifiableedges.com did a study that looked at what stock market returns had been after small cap stocks formed a death cross. Here are their comments and results regarding their death cross study …
“It is being promoted as a warning of a potential bear market. Of course, all bear markets will see this happen at some point, because a bear market is an extended decline. But the real question when considering the implications of the Death Cross are whether it serves any value in predicting a bear market. To answer this, I did an examination of past Russell Death Crosses, and what they meant for the S&P 500. Both of my data sources show Russell data back to late 1987. And since I need 200 days to calculate a 200-day moving average, the earliest the study could look back to was 1988”.
In their study, they purchased a hypothetical $100k in the SP500 stock index, each time a death cross occurred in the small cap index and sold the index once the 50 day moving average crossed back above the 200 day moving average. If the death cross were a viable stock market sell signal, this study should show a loss since we are doing just the opposite of the “signal” … here are the stats, profit curve of the hypothetical trade and ending comments. “
“Eighteen winners. Only three losers. So 86% of the “predictions” were wrong” and a total net profit of over $78,000 on a $100,000 investment. As such “I am having a hard time seeing the Russell 2000 Death Cross as a bearish indication. You would have a much easier time convincing me this is a bullish indication for the intermediate-term.”