Testing the “Golden Cross” and “Death Cross” on the SPY

The investing community is surprisingly divided on the usefulness of technical analysis, so today I wanted to put a few classic scenarios to the test. Namely, the “Golden Cross” and the “Death Cross.”

Both of these are moving average crossovers. The “Golden Cross” occurs when a stock or index’s 50-day moving average crosses up and over its 200-day moving average. The “Death Cross” is the inverse, where the 50-day line crosses below the 200-day.

Both events indicate that shorter-term price action (momentum) has overpowered the longer-term trend, with the expectation that the longer-term trend will follow suit. In other words, a bullish cross signals that short-term price action is favorable and the expectation is that it will precede a rising longer-term average (and continued rising share prices).

By that same token, the “Death Cross” indicates that short-term price action is overwhelming support levels and points to even lower prices ahead.

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Some analysts, like my former value-investing colleague Bruce Kaser, view technical analysis as little more than lines on a screen (online communities derisively refer to it as “crayon drawings”). If you’re a value investor, price movements are an opportunity to buy when the market is undervaluing your stocks or sell when the market is overvaluing them. In either case, the value of the underlying company is unchanged. Benjamin Graham used the analogy “Mr. Market” to explain that viewpoint.

On the other end of the spectrum are the high-paced day traders who can trade anything under the sun if they’ve got the right combination of technical indicators and studies. Most individual day traders do not beat the market.

As for Cabot, our analysts fall somewhere in the middle, but Mike Cintolo’s approach to technicals is a healthy one. Just one piece of the puzzle to be used in a more holistic approach. In Cabot Growth Investor, Mike will sometimes refer to the “SNaC” approach, which is to say the “Story, Numbers and Chart.” The chart doesn’t tell the whole story, but it tells part of it.

To find out who’s right, let’s dive into some numbers on the S&P 500 ETF (SPY) using moving average crossovers as buy and sell signals.

Testing the “Golden Cross” and “Death Cross” as Buy and Sell Signals

For our exercise, we’ll compare performance over the last five years. A golden cross will trigger a buy on the next trading day at the open. A death cross will trigger a sell on the next trading day, also at the open.

As you can see on the chart above, there are four instances where the 50-day moving average crossed over the 200-day moving average in the last five years (we’re using simple moving averages; you can read more about the distinction between simple and exponential moving averages at this link).

We’ll compare that performance to simply buying the SPY five years ago.

The Performance of Buy-and-Hold

If you bought the SPY on July 18, 2019, and held it through today, an initial investment of $10,000 would be worth $20,173, a return of 101.8%, or just over 15% annually (assuming you reinvest dividends).

You’ve doubled your money in five years, which is great and exceeds the long-term average returns of large-cap stocks.

The Performance of Market Timing with the Golden and Death Crosses

Right off the bat, we’re faced with a conundrum: Should we invest in the SPY? If we’re using golden crosses as our entry triggers, what do we do when our first trigger is a death cross (sell) in March of 2020, eight months after our window begins?

That’s a very real concern, and one we’ll discuss later, but for now, we’ll track two performance numbers: One in which you buy on the first trading day of our period because the last event was a buy signal (50-day line over the 200-day line means the last signal we would have gotten is a golden cross), and a second where we do not buy until a subsequent crossover tells us to.

Here are the results of both of those scenarios (both assume dividend reinvestment as well):

As you can see, if you simply bought at the beginning of our exercise and then subsequently followed buy and sell signals (scenario 1), you would have drastically underperformed simply buying and holding.

If, on the other hand, you had exclusively used crossovers as your buy and sell signals, you would have enjoyed comparable returns to buying and holding and you would have done so in a shorter period of time, potentially freeing up capital for other investments or, at the very least, generating additional returns on free cash.

To further cloud the picture, using the golden cross and death cross triggers would have outperformed buying and holding if your initial entry dates (July 6, 2020) were the same (a $10,000 initial buy-and-hold investment would have become $18,641).

What can we, as investors, take away from this? For passive investors, the old adage that “time in the market beats timing the market” is a good rule of thumb. If you have no plans to actively manage your account other than periodically rebalancing your 401(k) or IRA, your best bet is to just put your money to work.

But, if you’re an active investor who’s trading within a well-defined system, it is possible to outperform the market.

In our example, even the biggest “loser” (scenario 1) did fairly well, generating a 67% return in just five years. But that scenario is emblematic of a problem that many aspiring traders fall victim to – namely, inconsistent use of (or deviation from) a system.

In the hypothetical, the initial purchase was made like a buy-and-hold investor, but all the subsequent trades were made based on technical indicators. By mixing systems, scenario 1 generated 30% lower absolute returns over the last five years.

If that investor had simply sat on their hands and waited for a buy signal (scenario 2) they would have done just as well as someone that bought and held.

To sum it up, stick to your system, whatever that may be.

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