If you are a professional stock trader, you must have already heard about the term the Golden Cross. Newer or retail traders may find themselves stranded whenever they near the word Golden Cross regarding stock trading. Regardless, today, we will enable you to answer the basic question, what is a golden cross, and what is the significance of the Golden Cross in trading.
So, without further ado, let’s commence widening our fundamentals of stock trading and technical analysis.
What Is A Golden Cross?
The Golden Cross is referred to as a candlestick stock trend that signals future bullish movements of a stock. When the comparatively short-term moving average of a stock crosses over its long-term moving average, the stock is said to have crossed over.
The Golden Cross is a pattern indicating bullish breakout of stock and is formed by the comparison of a security’s long-term moving average (say the 50-day moving average) and its relatively short-term moving average (say the 15-day moving average).
The long-term moving average carries more weight, and resultantly the shorter period gains take a longer time to translate into an enhanced long-term moving average. Due to this, the short period or recent rally may have led the short-term moving average of the security over and above the long-term resistance level.
That statistical Cross of the moving average is referred to as the Golden Cross in the world of finance. Keep in mind, the Golden Cross is relevant only for publicly traded stocks and not bonds.
What Does The Golden Cross Represent?
In totality, the process of the stock Golden Cross is divided into three different stages. In the first stage, the selling of a stock depletes that leads to an eventual bottom out of the ongoing downtrend.
In the next stage, the short-period moving average begins to rise up towards and through the long-term moving average giving rise to a golden cross.
In the third and final stage, the uptrend continues to get past the higher weighed long-term moving average. To understand the phenomena better, you must know that post the third stage, as mentioned above, the ongoing long-term moving average acts as support levels on pullbacks.
Due to the reverse movement of the short-term moving average, the trend can also convert into a downtrend, and due to this, the short-term moving average can get equivalent to the long-term moving average for the second time, but this time in a reverse momentum, this Cross is called a death cross.
A death cross is the complete opposite of a Godden cross. As the shorter moving average on a downward trend forms a crossover through the longer moving average, a death cross is formed. On Wall Street, most analysts and experts continuously refer these two terms and crossing over.
There can be many moving averages under the umbrella of terms, short-term and long-term, but the most popular and commonly used averages are the 50-day moving averages for short term and the 200-day moving average for the long term.
Any period shorter or longer than these two respectively is considered to be highly and often unreliably volatile for averages representing even shorter periods, and if more than a 200-day moving average is taken into the analysis, the then average is considered to take too long for reflecting the breakouts.
These technical analysis tools are used widely not only to predict the future bullish performance of securities but also to identify bullish signals of market indices as a whole. In fact, the 50-day moving averages’ crossover with the 200-day moving average on the upwards trend of the most popular indexes likes the S&P 500 is widely considered a great signal that predicts the bullish market.
Benefits Of Using The Golden Cross
These crossovers are useful for all kinds of investors. If you are value or a long-term investor, you surely need to do your thorough research and fundamental analysis before financing a stock, but it is also equally important to determine how much you are willing to pay for the said stock.
If you feel like the prices are way too high despite being an attractive stock, there is no point in investing as your ROI wouldn’t be impressive.
For that purpose, technical analysis tools like the Golden Cross and Death Cross essential to identify the right moment and price to buy the stock. On the other hand, the importance of the Golden Cross and Death Cross for a Stock trader is not even required to be explained.
The whole purpose of trading is speculating, as you are speculating a certain uptrend or downtrend of a stock in order to make use of that in following the good old formula “buy low, sell high” and earn profits.
If you are a day trader, you would be better off using an even shorter time period for moving averages for both long-term and short-term, for obvious reasons.
The most common averages used by day-traders throughout the world for identifying Golden Cross breakouts are the 5-period and 15-period moving averages. One basic rule that you must not forget while using the Golden Cross is that longer the period used, stronger the signals.
So, if you identify a rather convincing trend during the short periods, you can determine strong the signal really is by adjusting and using longer-time periods. The stronger the signals are, the stronger and lasting the Golden Cross breakout is likely to be.
Difference Between A Death Cross And A Golden Cross
As explained briefly above, a death cross is the exact opposite of a Golden Cross. A golden cross is a signal of a long-term bull market while moving forwards; on the hand, a death cross is a long-term indicator of a bearish market.
They are both considered strong indicators of a particular long-term trend of the security or market by the crossing over of short-term moving averages though the long-term moving averages.
The Golden Cross occurs when a short–term moving average of the security crosses the long-term moving average of the stock. It is considered by analysts a reliable indicator of a promising positive trend in the long run.
On the other hand, when a short-term moving average crosses the long-term moving average in a downtrend, analysts call it the death cross, and it is considered an indicator of an overall price decline in the future.
The long term moving average becomes the support level in the post-Golden cross run and the resistance level in the post-death cross run.
Limitations Of Using The Golden Cross
Every technical indicator is inherently “lagging,” and none of them can predict the future with utmost accuracy. The same applies to the Golden Cross. Moreover, there have been times where the Cross has yielded negative returns.
So, it is best to rely on the Golden Cross indicator only in combination with other indicators implying the same trends instead of blindly following The Golden Cross or any other technical indicator for that matter.