How to trade the S&P 500 'death cross' formation

Published Mon, Aug 31 20156:00 AM EDT

First it was Apple , now the S & P 500 has followed, forming a death cross pattern on a daily basis for the first time in four years. A death cross occurs when the short-term moving average of a security or an index pierces below the long-term trend, in this case the 50-day moving average breaking through the 200-day moving average—a sign of fading momentum and possibly more short-term losses ahead. "We have been progressively more cautious the last three months moving into this decline," said Louise Yamada, managing director at Louise Yamada Technical Research Advisors. The technical strategist explains that daily short-term crosses are often viewed as yellow lights, but they are not as relevant as the long-term crosses, which often carry greater significance for market watchers. On a weekly basis, a measure of intermediate-term strength, the death cross is also in place for indexes like the S & P 500 , Dow and the NYSE composite, a progressive step to trouble, according to Yamada. Source: FactSet Since 1950, there have been 32 times when a death cross occurred for the S & P 500, according to Joe Bell, senior equity analyst at Schaeffer's Investment Research. The formation of a death cross resulted in the S & P underperforming its average returns over one-, three- and six-month time frames, with the index posting positive returns only half of the time, Bell's analysis shows. On a long-term basis, the index posts a positive return 70 percent of the time, up on average 3.9 percent, but still underperforming the average 12-month return of 8.9 percent since 1950. "I don't think the volatility storm has passed," said Todd Gordon, founder of TradingAnalysis.com, pointing to the weakness in other indexes like the Nasdaq 100 and the small-cap Russell 2000, which remain down more than 7 percent and 10 percent, respectively, from their highs this year. Apart from the death cross, other market observers think that it's key for investors to monitor the slope of the 200-day moving average. "To me, if you are going to use one technical indicator that tells you we are now in a bearish trend, it is the direction of the 200-day moving average," said market technician Ryan Detrick. "If the 200-day moving average is pointing higher, that can negate just about any bearish signals. But once the 200-day rolls over, like it did in January 2008, that was your warning that things could be about to get ugly," Detrick added. Since Aug. 19, the 200-day moving average on the S & P 500 has started to roll over, although it seems too early to determine whether this is a sideways move or the start of further deterioration. MKM Partners' chief market technician, Jonathan Krinsky, warns that if the slope of the long-term trend begins to turn down, it would be a "big negative" for the market. Read More Stocks could be in early bear market: Ned Davis

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First it was Apple, now the S&P 500 has followed, forming a death cross pattern on a daily basis for the first time in four years.

A death cross occurs when the short-term moving average of a security or an index pierces below the long-term trend, in this case the 50-day moving average breaking through the 200-day moving average—a sign of fading momentum and possibly more short-term losses ahead.

"We have been progressively more cautious the last three months moving into this decline," said Louise Yamada, managing director at Louise Yamada Technical Research Advisors.

The technical strategist explains that daily short-term crosses are often viewed as yellow lights, but they are not as relevant as the long-term crosses, which often carry greater significance for market watchers.

On a weekly basis, a measure of intermediate-term strength, the death cross is also in place for indexes like the S&P 500, Dow and the NYSE composite, a progressive step to trouble, according to Yamada.