It's official, on August 11, the S&P's 50-day simple moving
) sliced below the 200-day SMA. This condition is dramatically
called the death cross.
The death cross has foreshadowed some remarkable market
meltdowns (-46% in 2000 and -55% in 2007) and shouldn't be ignored.
However, it also has one serious flaw.
Just a few months ago the S&P was trading at 1,370. Those
were golden times, but they've passed. Reality paid a visit and the
S&P dropped as much as 267 points, or 19.48%.
The S&P has recovered somewhat but is still 15% below the
May high. If you're holding on to long positions until you get the
crossover sell signal (or death cross), the last few months have
been a grueling experience.
Why? Simply because your sell signal has been late to the party,
15% too late.
The Serious Flaw
Merely using the SMA crossover as buy/signal is like having to
wait for an important document sent via snail mail when it could
have just been sent via e-mail.
Yet, that's exactly what the financial media is doing -
investment advice in the snail mail format. To illustrate what I
mean, allow me to quote some headlines featured around May 2,
'The S&P Breaks Out'
'Sales growth the Big Surprise on Wall Street'
'Why Berkshire and Buffett Never Lose'
'World revs up U.S. Profits'
'Geithner: No risk U.S. will lose AAA Credit Rating'
Quite to the contrary, the May 1 ETF Profit Strategy Newsletter
update showed two revealing charts (the first chart is shown below)
'The first two charts update the S&P's position relative to
various resistance levels and the ideal target range for a
potentially historic market top. The first chart provides a big
picture snapshot going back as far as 1997. As mentioned before,
the ideal target range is between 1,369 and 1,382. 1,369 is a
Fibonacci projection level going back to the 2002 market low. A
move to 1,369 would be close enough to consider the right side of
the giant M-pattern as completed.'
On July 28 the ETF Profit Strategy update commented about
support at the 200-day simple moving average (
): 'A break below the 200-day SMA and the trend line may trigger
panic selling. One way to avoid missing out on a potentially big
opportunity is to use the 200-day SMA at 1,284 as delineation
between bullish and bearish bets - buy as long as the 200-day SMA
serves as support, sell if it becomes resistance.'
The death cross (like Wall Street and the financial media) is
like a seemingly concerned bystander offering you an umbrella after
you've gotten trenched by the rain.
Death Cross Track Record
How big of a deal is the death cross? A picture (or table) says
more than a thousand words. The table below shows every death or
golden cross since 2000. A golden cross is the opposite of the
As you can see, the death cross - albeit late - has protected
investors from much more severe declines in 2000 and 2007. There
were some false alarms, but the damage of the misfires were
miniscule compared to the benefit of the warnings which is
reflected in the 19.7% average gain of a winning trade (7.6%
average loss for a losing trade).
To sum it up in one sentence, the SMA crossover is correct 6 out
of 10 times with a risk/reward ratio of 3:1 in favor of the
One interesting little factoid about the 2000 and 2007 death
crosses is that the sell signal - albeit late - occurred right
before the next powerful decline.
In 2000 and 2007, stocks rallied for about three days before the
grip of the death cross took hold and drew the major averages a la
S&P (SNP: ^GSPC), Dow Jones (DJI: ^DJI), Nasdaq (Nasdaq: ^IXIC)
and Russell 2000 (Chicago Options: ^RUT) significantly lower while
propelling the VIX (Chicago Options: ^VIX).
Super Charge the Crossover Sell Signal
This harmonizes with our analysis that there's a good chance
stocks will drop to a new low.
Fortunately since we've been either in cash or short stocks
since S&P 1,340, we do not feel the need to chase the market.
Right now it's best to simply follow the market's lead. What does
If you look at a chart of the S&P 500 you will see that on
each of the last four days the S&P has closed either at 1,173
or 1,121. Already in June the ETF Profit Strategy Newsletter
pinpointed S&P 1,170 is important support/resistance level.
On July 15 the newsletter reiterated: 'A close below this year's
low at 1,249 on the other hand would probably mean that a major
market top has been reached and should minimally lead to S&P
1,229 or 1,170.'
The August 4 update again highlighted the importance of 1,121
and 1,173. No doubt the S&P will break out of this range soon,
but until it does - and even once it does - 1,173 and 1,121 are
important inflection points.
Trade above either level keeps the notion of higher prices on
the table while trade below would point towards lower prices and
quite possibly a new low.
Profit Strategy Newsletter
boils down complex technical analysis into easy to understand
support/resistance levels and actionable buy/sell recommendations.
It also provides the target level for the ultimate low and the top
end of any counter trend rally.