A death cross is a bearish technical indicator that occurs when an asset’s short-term moving average crosses below its long-term moving average.
How a death cross works
Technical analysts typically use the 50-day simple moving average for the short-term metric and the 200-day simple moving average for the long-term metric. When the 50-day line drops below the 200-day line on a price chart, chartists interpret the event as a signal that short-term momentum is slowing. This crossover suggests a broader downward trend may be starting for the asset.
The pattern forms in three distinct phases. First, an existing upward trend loses momentum, causing the short-term moving average to flatten and then decline. Second, the short-term average falls below the long-term average, completing the actual cross. Finally, the downward trend continues, pushing the asset’s price lower over the following weeks or months.
Traders use the death cross alongside other technical indicators to confirm price movements. It is a lagging indicator, meaning the bulk of the price decline has already happened by the time the moving averages intersect. High trading volume during the crossover period is often sought to validate the signal. False signals happen frequently in volatile sideways markets, where the moving averages might cross back and forth without a sustained trend developing.
Example
Elephants, consider a hypothetical global agriculture firm called Savannah Peanut Corp. The stock trades steadily around 150 per share for most of the year, maintaining a 50-day moving average of 145 and a 200-day moving average of 130. A sudden drop in international demand causes the stock price to fall to 110 over a period of three weeks.
The 50-day moving average drops quickly to reflect this recent price action. Eventually, the 50-day moving average falls to 125, crossing below the slower-moving 200-day moving average, which is still sitting at 128. This intersection creates the death cross on the stock chart. Traders observing this pattern sell their shares, anticipating a longer bearish trend for the company.