Many investors who base their forecasts on technical analysis were shaken when a rare death cross appeared in the chart of the Dow Jones Industrial Average (DJIA), a phenomenon which they believe indicates that the stock market may be entering a new long term downtrend.
The signs of an approaching death cross have been apparent to chart watchers for some time, but are still seen as a frightening bad omen for bulls when it actually shows up.
Increasing unease is being felt because of the fact that not only has the Dow Industrials (DJIA, -1.21%) illustrated the phenomenon, but the Dow Jones Transportation Average (DJT, -0.33%) has done the same, adding weight to bullish investor fears.
A death cross is the pattern made on a chart when a market's long term moving average breaks above its short term moving average or support level. The general trend periods followed are the 200 day moving average as a long term measure and the 50 day moving average used by investors to track the short term trend. The occurrence of the death cross is viewed by many as the sign of an imminent bear market, or time to sell.
According to FactSet, the appearance of the cross on the Dow Industrial chart, which closed on Tuesday at 17,806.99, was the first time the 50 day moving average had closed below the 200 day moving average, forming the cross, since 30 December 2011. The index, which had a record close of 18,312.39 on 19 May, has been moving steadily downward since closing 1.2% down on Tuesday, its eighth loss in the last nine sessions, to be down 5% since 19 May.
The result of this is that many technical analysis forecasters believe this to be the point at which a short term market decline changes into a long term downtrend.
The argument has been made that the cross has very little predictive accuracy since some previous crosses have become apparent after a market has bottomed. An example of this is the death cross which became apparent on 7 July 2010 with the Dow closing at 10, 0128.28. The lowest recorded closing for the year of 9,686.48 had in fact been two sessions earlier.
The difference is that when the 50 day moving average crosses the 200 day moving average while on a downtrend, trouble appears to be imminent. In the other case, the 50 day average is moving upwards when it crosses the 200 day line which indicates the opposite trend. The closing index value of any one day has far less effect on the 200 day moving average than it has on the 50 day average which means the graph depicting the longer period always lags behind the graph of the shorter period, making the cross possible as the accompanying charts show.
One to watch is the S&P 500 index (SPX, -0.96%) with the 50 day moving average at 2,095.69 and dropping by almost a point a day, while the 200 day moving average reads 2,074.80 and is rising by almost a point daily. The cross is imminent in this case.
Conversely, the Nasdaq Composite index (COMP, -1.27%), with a 50 day reading of 5,078.91 and a 200 day average of 4,895.64, is still in safe territory.