The Nifty50 turned negative for 2019 on September 17. But the situation only seems to be getting worse as more than 60 percent of the constituent companies registered the formation of a ‘Death Cross’ on the daily candlestick charts, indicating the potential for a major selloff.
As many as 32 companies in the Nifty50 recorded a formation of Death Cross. These include Eicher Motors, Maruti Suzuki India, Bajaj Auto, Hero MotoCorp, Dr. Reddy’s Laboratories, Britannia Industries, and L&T among others.
In the Nifty500, as many as 350 stocks witnessed the formation of a Death Cross on the daily charts. These include MRF, Page Industries, 3M India, Eicher Motors, Wabco India, TTK Prestige, ICRA, Bosch among others.
In technical terms, the Death Cross is a technical chart pattern which points towards a potential for a major selloff in the stock or index. It is formed when the short-term moving average crosses below its long-term moving average.
Typically, the most common moving averages used by technical experts in this pattern are the 50-day and 200-day moving averages.
Since touching its all-time high of 12,103 in June 2019, Nifty has lost more than 10 percent due to factors such as the fear of economic slowdown and mounting geopolitical concerns. The most recent pummel can be attributed to sudden rise in crude oil prices, which shot up tremendously in the wake of drone attacks on Saudi oilfields on September 14.
A Death Cross is considered a bearish signal and traders are advised to stay cautious in the aforementioned stocks as the trend seems to be on the downside. But, it can also be viewed as an opportunity for long term investors, who can pick stocks with strong fundamentals that are currently in the rut due to recent headwinds.
“Investors have historically feared the stock market Death Cross, hence the word “death” in the name. Considered a bearish signal, stock market Death Cross can usher in waves and waves of fear and this often can trigger a selloff but we have seen that 50 percent of the times markets did not fall meaningfully,” Deepak Jasani, Head Retail Research, HDFC Securities told Moneycontrol.
“Key stock market Death Cross have occurred over the history of the stock market. There are 6-8 such past instances recorded for Nifty50 and Nifty500 since 2003. On March 23, 2008; March 4, 2011; October 20, 2015 these Death Crosses occurred on the eve of the most spectacular market crashes in history,” he said.
Jasani further added that Nifty has witnessed some whipsaws i.e. on August 6, 2013, January 3, 2017 and on November 20, 2018 as there was no meaningful correction after the formation of Death Cross. Hence in 50 pecent of cases, Nifty did not fall significantly after forming of a Death Cross.
The relevance of the Death Cross reduces due to the fact that it is a laggard signal. It comes at a time when most of the other parameters are also suggesting a similar trend.
But, it does act as a confirmation signal for most traders and validates the bearish trend seen in the stocks. At this juncture, without any second thought, larger part of the market slipped into bearish phase since January 2018 correction.“The current Death Cross formed when 50-day moving average below its 200 days is only pointing out that long term trend is in a bear grip. This indicator is a laggard shall not be construed as a fresh sell signal on charts as many of the momentum oscillators on intermediate time frame are already in sell mode as stocks already witnessed deep correction and hence basket selling should be avoided,” Mazhar Mohammad, Chief Strategist – Technical Research & Trading Advisory, Chartviewindia.in told Moneycontrol.
“Best basket selling opportunity may arise once Nifty decisively breaches August 2018 lows of 10637 as that may set in enough panic in the market facilitating bigger sell-off,” he said.
Is there a shorting opportunity?
The stocks which have registered a Death Cross on daily charts suggest that the trend is bearish but it does not necessarily mean a shorting opportunity, experts suggest. However, it could turn out to be good opportunity for long term investors, they added.
History suggests that the Death Cross regularly produce false signals. Therefore, a Death Cross should always be confirmed with other signals and indicators before putting on a trade.
“This signal may not fail if it breaches the recent low (low prior to forming the signal). The average correction expected due to Death Cross is 10-12 percent (index) and in stocks 15-18 percent (largecap) 20-25 percent mid & smallcap,” said Jasani.
“The probability of fall in Nifty increases when the recent low is taken out. Hence traders must wait for high probability set up to create fresh shorts,” he said.
Jasani further added that the latest low in Nifty is 10,637 and the index is currently trading at 10,817 as of Tuesday's closing. Any move below this level (10,637) could lead to further correction in markets which could result in a shorting opportunity.
Other signals to use:
Now that we know that this a laggard indicator, traders should add a couple of more indicators such as RSI or relative strength index or ADX while punching a buy or a sell order.
When the Death Cross if formed we might probably be somewhere in the middle of a bearish trend. Since this lag is huge it may be followed by some consolidation but the overall indication is that trend is negative for now, suggest experts.
“Apart from Death Cross traders could use many other indicators such as Relative Strength Index which shows the strength in prices if they are sustaining above some long term moving average. A reading above 50 shows bullish bias while above 60 shows strong strength in prices,” Mustafa Nadeem, CEO Epic Research told Moneycontrol.
“But, post a death cross signal, this can help identify oversold opportunities. ADX is another indicator that shows the strength in trend. One should also observe that Death Cross may be happening on a daily scale and it has a lot of noise. So one should also look at Weekly or Monthly Scale,” he said.
Jasani of HDFC Securities recommends Bollinger Bands which will also help to identify the volatility cycle, so that traders can avoid shorting during excessive volatile times or after an extended down move.
“Two classic price pattern has been witnessed in the past before any major trend reversal to up i.e. double bottom and Inverted head and shoulder. Double bottom (March 2009, January 2012, March 2016 and Oct 2018); Inverted Head & shoulder (Sep 2009, in progress since July 2019),” he said.
Disclaimer: The views and investment tips expressed by investment experts on moneycontrol.com are his own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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