What Is a Golden Cross?

What Is a Golden Cross?

Let me tell you directly: a golden cross is a pattern you see on a chart when a short-term moving average crosses over a longer-term moving average to the upside. It's a bullish breakout pattern that happens when a security's short-term moving average, like the 50-day one, crosses above its long-term moving average, such as the 200-day, or a resistance level. This indicates the possibility of a long-term bull market starting to emerge. High trading volumes usually reinforce this indicator, making it more reliable.

Key Takeaways

Understand this: a golden cross is a technical chart pattern that points to the potential for a major rally. It appears when a stock’s short-term moving average crosses above its long-term moving average. You can contrast it with a death cross, which signals bearish price movement. Since it's a lagging indicator, you should use it alongside other tools in your decision-making process.

Understanding Golden Crosses

The golden cross is a tool in technical analysis, and it's a momentum indicator, meaning prices are continuously increasing and gaining momentum. It shows that traders and investors have shifted their outlooks from bearish to bullish.

This indicator generally has three stages. First, a downtrend eventually bottoms out as buyers overpower sellers. In the second stage, the shorter moving average crosses over the larger one, triggering a breakout and confirming a reversal from the downward trend. The last stage is the continuing uptrend after the crossover, where the moving averages act as support levels on pullbacks until they cross back down.

Fast Fact on Support and Resistance

Here's a quick note: support is a low price level that the market doesn't allow to go below, while resistance is a high price level that the market resists breaking through. A breakout happens when the price crosses one of these levels.

Moving Averages Used with Golden Crosses

The most common moving averages for spotting a golden cross are the 50-day and 200-day ones. Longer periods tend to form stronger, lasting breakouts. For instance, a 50-day moving average crossing up through the 200-day on an index like the S&P 500 is one of the most popular bullish signals.

Day traders often use smaller periods, like five-day and 15-day moving averages, for intra-day golden cross breakouts. You might choose different periods, such as weeks or months, based on your trading preferences and what works for you. But remember, the larger the chart time frame, the stronger and more lasting the golden cross breakout tends to be.

One important point: a golden cross isn't an indication that investors will sell their shares.

Example of a Golden Cross

Consider this example using a 50-day and a 200-day moving average. The 50-day moving average trended down over several periods, finally hitting a price level the market couldn't support. The 200-day moving average flattened out after a slight downward trend.

Prices then gradually increased, creating an upward trend in the 50-day average. This trend continued, pushing the shorter-period average above the longer one. A golden cross formed, confirming a reversal from down to up.

Notice how the price range of the candlesticks jumped significantly when the downward trend bottomed out and turned upward. Something likely shifted investor and trader sentiments at that point. The candle bodies were large, showing big differences between open and close prices, and more days closed much higher than they opened during the initial uptick after the 50-day bottomed.

Golden Cross vs. Death Cross

A golden cross and a death cross are opposing indicators. The golden cross confirms a long-term bull market ahead, while a death cross signals a long-term bear market. Either is more significant with high trading volume. In a death cross, the short-term moving average crosses from above the long-term one, whereas in a golden cross, it crosses from below.

Once the crossover happens, the long-term moving average becomes a major support level in a golden cross or a resistance level in a death cross for the market going forward. These crosses may signal a trend change, but they often occur after the change has already started.

Limitations of a Golden Cross

All indicators are lagging, meaning they use data that's already happened, so they're reactive rather than proactive. No indicator can truly predict the future. Often, a golden cross produces a false signal.

Despite its power in forecasting past bull markets, golden crosses regularly fail to deliver. Therefore, always use other signals and indicators, especially leading ones, to confirm it.

Is the Golden Cross Always Bullish?

The golden cross happens when a short-term moving average crosses over a long-term one to the upside, and analysts interpret it as signaling a definitive upward turn in the market. This reflects a bullish outlook by investors.

What Does a Golden Cross Mean?

A golden cross suggests a long-term bull market ahead. It's the opposite of a death cross, which is bearish and forms when a short-term moving average crosses a long-term one from above.

How Reliable Is the Golden Cross?

As a lagging indicator, a golden cross is identified only after the market has risen, making it seem reliable. But due to the lag, it's hard to spot false signals until afterward. Traders often use it to confirm trends in combination with other indicators.

The Bottom Line

A golden cross is believed to confirm the reversal of a downward trend. To use this technical tool correctly, apply it with additional filters and indicators, and incorporate profit targets, stop losses, and other risk management tools. Maintain a favorable risk-to-reward ratio and time your trades properly rather than following the cross blindly.