Month: May 2010

Stock Market Death Cross and an Inside Day.

If the title of this post seems strange to you, then you’re about to be enlightened. Last week was the worst week for the stock market since 2008. The Dow lost 4.51%, the S&P lost 5.03% and the Nasdaq lost 5.92%. There were a couple of other interesting things that happened on Friday as well. This includes the dreaded “Death Cross” and it was also what is known as an “Inside day”. Here’s the breakdown of what the heck that means.pic3

First: The Golden Cross

The Golden Cross is when the 50-day simple moving average crosses the 200-day simple moving average. This is considered to be a lagging indicator, meaning that it will occur after a trend change has already begun. The trend that follows after a Golden Cross can be very strong, partly because several institutional investors see this as a buying signal and it gives them the confidence to bring additional funds to the table.

The Golden Cross in June of 2009 was followed by a rally of about 31%.

Then: The Death Cross

The Death Cross is when the 50-day simple moving average crosses below the 200-day moving average, which is exactly the opposite of a Golden Cross. Again, it is considered to be a lagging indicator because it can only happen after a dip, correction or during a longer existing downtrend. Many investors see this as a very bearish sign and they often sell off in anticipation.

Historical performance of Death Crosses is not as bad as one would imagine, given the name and the great performance of Golden Crosses. The 2008 Death Cross was followed by an extraordinary drop of about 50% and is still fresh in people’s minds.

S&P 500 Daily Chart

This does not necessarily mean that we will have another steep drop. Historical performance of the indexes after a Death Cross has had mixed results including market rallies. Such was the case in 2004 when the markets soared 48% after a Death Cross.

Inside Day

Friday’s price action is what is known as an “Inside Day”. This means that the highs and lows of the market on a given day does not exceed the highs and lows of the previous day. In other words, the price action was confined inside the previous day’s range.

This typically signals a trend reversal, which could last or be very short-lived. Since we are clearly in a downtrend now, it could signal a snap-back relief rally fueled mostly by short-covering. The reason I don’t say that it would be fueled by bullish investors is because they have had so many opportunities to jump in and rally but have repeatedly failed to do so. The bulls have given up key support levels and the bears need a rest before they try to take another bite out of the markets.

These are undoubtedly exceptional times. It is futile to try and predict every move the market makes, so I just try to trade the setups that are provided to me. At times this means not trading anything at all until an opportunity presents itself. If you’re looking to buy some stocks for the long-term, I suggest waiting on the sidelines for awhile longer. I say this despite having said that I expect a sharp relief rally earlier because that’s all it will be, a relief rally. Probably not a full-blown bull run and if it is, then you will have plenty of opportunities to get in without taking the risk of potentially steep draw downs.

Leave a comment below and let me know what kind of outlook you have on the markets. I would really like to hear what kind of time horizon you are looking at, whether you’re a day trader or long-term investor.

Stay tuned.