BEFORE the bottom fell out of the S&P 500 last August, alert traders were given a sign in the data that something was about to give. In the last few days, a similar warning has come to watchers of gold price charts, suggesting the yellow metal will decline in value over the coming days and weeks. The threatening technical indicator, which signalled the risk of a precipitous fall in US stocks and tips the overturning of a long-term bull market in gold, goes under an appropriately dramatic name: the death cross.
AT A CROSSROADS
Under the cover of the theatrical name lies a simple technical tool. A death cross is simply when an asset’s 200-day moving average breaks above its 50-day moving average. This cross signals the possibility of change you should believe in – or at least monitor closely. Chris Beauchamp of IG Markets, says such a moment often signifies a change in a trend, and the crossover provides a useful tool for traders hoping to identify when to enter or change direction on a trade.
Mike van Dulken, head of research at Accendo Markets, explains that although simple moving averages by themselves are lagging indicators, when used in combination with other moving averages, they can be extremely helpful in identifying shifts in trend. He notes: “Moving average crossovers signal key shifts in momentum and support/resistance when a shorter term moving average moves up/down through a longer-term counterpart.”
DEATH AND TAXES
Nothing is certain – including death crosses. Van Dulken notes that moving average crossovers work best when shares are trending. As such, moving averages lose their power – and oscillators work better – when trading is sideways, because prices can become trapped between the 50 and 200-day moving averages, moving repeatedly between the extremes.
Beauchamp warns that moving averages can give false signals – with the trend simply pausing before continuing on its way. He says “some refinements can be added that may help improve the effectiveness of a strategy based on these crosses. To this end he suggests using an average directional indicator (ADX), which can help gauge the strength of a trend: “When this indicator rises above a certain level, usually 25 and above, it indicates a strong trend that will continue. If a cross occurs when the ADX is below this level then traders may take this as a sign that the cross is a false signal, and refrain from trading.” Beauchamp also offers this more fundamental piece of advice: “To paraphrase Harold MacMillan, events will often intervene.” As such, any positions on gold’s decline could be undermined by central bank activity.