Why You Must Confirm a Death Cross
By now, you’re well aware of how to find trends using simple moving averages, such as the 50- and 200-day moving averages. But you should also know how to potentially spot when a trend could stop dead in its tracks, or birth a new trend.
All we have to do is wait for a crossover to do so.
For example, we can spot a bullish “golden cross” when the short-term moving average, such as the 50-day crosses above the longer-term average, such as the 200-day. When this happens, we’ll typically see a move higher in a stock or an index.
Or, we can spot the bearish “death cross” when the short-term average, such as the 50-day crosses below the longer-term average, such as the 200-day. When this happens, we’ll typically see a move lower in a stock or index.
However, it is essential that you always confirm your findings before you buy or sell.
Look at what happened to Tesla (TSLA) in early December 2017. Even as the 50-day began to cross below the 200-day, the stock, signaling a potential downtrend, the stock decided to buck the trend and explode higher. Any one that took a short position based on nothing more than a crossover watched as their position went up in smoke.
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Unfortunately, technical signals derived from moving averages aren’t a great tool, and don’t often have a great success rate. In fact, such crossovers are often better at telling us what has happened than what could happen.
It’s why it’s essential that you do two things prior to buying or selling on a crossover.
One, confirm with other indicators, such as your Bollinger Bands, MACD, relative strength (RSI), money flow (MFI) and Williams’ %R, which have a better track record of predicting potential reversals higher or lower based on herd mentality. There will never be a time when it’s okay for a sole technical indicator to be used.
Two, confirm with patience.
Be patient enough to wait for higher closes over multiple days prior to buying what appears to be a change in trend. If, for example, we went short TSLA based on the appearance of a death cross without confirming its validity, we lost money.
If we fail to confirm the bottom is real, it’s a warning sign of a potential bear trap.
Plus, we also want to confirm if the break is real or not with a change in volume.
Consulting volume for confirmation of a potential break higher is essential to ensure changes in supply and demand.
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