Death Cross Sell Signal Analyzed

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". . .the death cross can cut massive losses short."

When used properly, the death cross can cut massive losses short. The death cross is so popular because many institutional investors use the 50-day moving average (MA) as a medium-term average and the 200-day as the long-term MA. Basically, the crossover method signals a sell signal when the shorter-term MA crosses the longer-term MA to the downside. A buy signal is identified when the short-term MA crosses the long-term average on the upside.

Crossover methods are easy to program into a computer, but you must use additional clues to create a sell signal. There are frequent whipsaws and failures when you use the crossover method in isolation.

Similarly, back testing the results of the death cross using a computer program won't produce optimal results, as technicians look for additional signs of the breakdown than just the cross.

If the crossover signal is confirmed with a head-and-shoulders breakdown, a cross into new lows and poor price volume action, which is occurring now, I'll patiently wait on the sidelines and look for prudent short points when I see a price reversal and the price coming up to certain resistance. If all these signs come together, the probability of a whipsaw is significantly reduced.

Also important to note—a death cross is further confirmed if the 200-day begins sloping downward after the break. This will act as resistance on the way down.

A look at the Dow death cross of January 2008 shows many signs of a market top and trend change.

Dow death cross of January 2008

The 200-day, which acted as previous support, was violated on high volume and followed by three failed rallies at the 50-day MA before crossing over. If not followed, investors would have lost more than 60% of their portfolios.

Now is the time to protect your portfolio; consider selling on any bear rallies. I believe this rally will come to an end shortly and we'll continue to trend lower in equities.

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