One of the oldest systems to generate buy and sell signals for equity indexes is the crossover of the S&P; 500’s 50-day and 200-day simple moving averages (M/As).
When the 50-day crosses the 200-day M/A from a level below, a buy signal is generated, which is also referred to as the Golden Cross. When it crosses from a level above, a sell signal is generated, which is also known as the Death Cross.
To demonstrate the effectiveness, I have marked the crossovers in the 7-year chart below. The buys are identified by a blue arrow, while the sells are marked with a red arrow:
[Double click chart to enlarge]
As you can see, using this approach, you would have participated in all of the “major” up moves of the past few years.
More importantly, you would have avoided the major downturns. It’s especially noteworthy that a sell was signaled late in 2007 with a new buy not being generated till the second quarter of 2009, causing an investor following this approach sitting on the sidelines throughout 2008.
While I don’t use this method in my advisor practice, I do observe its major turning points. What most investors will not like about this approach is that its buy signals are generated late within an up cycle. Case in point is the most recent Golden Cross, which just occurred during the middle of October.
However, if you are concerned with controlling downside risk, and are able to truly look at the big picture, without being distracted by quarter to quarter market idiosyncrasies, you should definitely be on the lookout for the Death Cross as your last line of defense.