A more deadly dead cross

Back in January, Ashraf Laidi alerted us to a strong sell signal in the euro currency based on the dead cross indicator. The indicator worked and provided those that followed it a successful short position that continued to pay dividends into May as the euro broke further (see chart).

Perusing various technical indicator sites shows that many technicians have their own take on defining the dead cross and the golden cross indicator. The basics involve a faster (shorter-term) moving average crossing below a slower (longer-term) moving average in the case of a dead cross (bearish signal) and the faster moving average crossing above the slower moving average in the case of the golden cross (bullish signal). Most technicians use either the 50-day and 200-day simple moving averages (SMA) or the 100- and 200-day SMA.

Laidi uses an added requirement that increases the upside of these signals. The trade is signaled — in the case of a dead cross — when the 50-day SMA crosses below the 100-day SMA when both averages are above the 200-day SMA and the current price of the underlying. In the case of the golden cross, the 50-day SMA moves above the 100-day while both are below the 200-day and the current price of the underlying.

The basic definition of the dead and golden cross indicators is a simple cross of the 50- and 200-day SMAs, but as you can see in the two examples of the dead cross in the chart below, applying the added requirement, you would have missed a significant part of the move if you waited for the 50-day to cross below the 200-day or the 100-day to cross below the 200-day. Also in the one example where the cross occurred while the longer 200-day average was below the 50- and 100-day SMAs, the strategy would not have worked. So in the three examples of a basic dead cross over the last two years on a daily euro chart, applying the added requirement would have gotten you into the two profitable moves much earlier and would have prevented you from getting into a dead cross when it would have been a losing trade.

The euro chart also shows an example of a golden cross with the added requirements in May 2009. In January there was a golden cross signal that would have resulted in a loss as the market whipsawed if you followed the simple definition. But even though the 200-day was above the two other moving averages, the market was below it so there was no confirmation based on the added requirements.

You should apply solid risk management principles like taking partial profits when entering a position based on this indicator but the signals are usually rare and meant to produce strong moves so you should give yourself room. The dead cross signaled in July 2008 produced a 24% move from peak to valley. That followed a 14% move based on a dead cross in 2005. The dead cross signaled by Laidi in January has produced a 12% move and may have some room to go.

This signal will work in many markets and different currency pairs, though Laidi prefers to apply it to the euro. It also works on multiple times frames. A successful dead cross was signaled on a weekly chart in the Canadian dollar in January. This followed a golden cross signal that moved significantly higher before reversing in 2009 (see chart).

The CAD may have produced the most profitable signal using Laidi’s additional requirements on the dead cross back in 2003 on a weekly chart. The short was signaled in February 2003 from about 156. That short could have been ridden to the 2007 lows, a more than 40% move. Perhaps a prudent trader would have taken profits or chose to avoid large corrections but the move indicates the potential of this indicator.

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