What is a Golden Cross?
The Golden Cross chart pattern is a bullish technical setup. This pattern is relatively simplistic and easy to recognize but carries the power to indicate a major potential rally. The Golden Cross forms when a short-term moving average crosses up and through a long-term moving average. Different traders use different periods, but at Wanderer we consider a Golden Cross to be when the 50-DMA crosses up through the 200-DMA.
The Golden Cross is identified through three stages:
The first stage occurs when a downtrend exists but is bottoming out as seller interest fades and is beaten out by buyer interest.
The second stage is where you will notice the golden cross. The 50-DMA will cross above the 200-DMA and act as confirmation that a reversal to an uptrend is taking place.
The third stage is a prolonged bull market. The uptrend should continue to higher and higher prices. During this stage, the moving averages are often support levels for any pullbacks.
Let's go through an example below.
Here, the S&P 500 progresses through each stage. In July 2020, you can see that the 50-DMA (red line) crosses above the 200-DMA (gold line) forming the Golden Cross. This would be a strong indicator of a bull market on the horizon. During stage three, the market is in a continued uptrend, and you will notice that the 50-DMA serves as a support level to any pullbacks in the market (orange circles).
The Death Cross
In contrast to the Golden Cross, there exists the Death Cross. Essentially, the Death Cross is the direct opposite, indicating the potential of a bear market. The Death Cross forms when the 50-DMA crosses below the 200-DMA.
The Death Cross can be broken into three stages:
The first stage occurs when there is a weak uptrend and prices begin to peak. Thereafter, you will notice the beginning of a downtrend as buyer interest is beaten out by seller interest, and prices begin to fall.
During the second stage, the 50-DMA crosses through the 200-DMA signaling a confirmation of the downtrend.
The third stage consists of a sustained bear market with the 50-DMA remaining below the 200-DMA.
Let's look at an example below.
Again, we can see the progression through the three stages of the Death Cross on the S&P 500. The price peaked in January, followed by a downtrend and eventual Death Cross (50-DMA falling down through the 200-DMA) in March. At this point, the cross would be a strong signal that the bear market will continue. In stage three, there is a prolonged downtrend, and the 200 DMA is a resistance level (orange circles).
Notice though, that the Death Cross didn't mean an immediate drop in the market. The Golden and Death crosses are indicators, but we do not use these as stand alone indicators. Instead we use them as additional confirmation to support an idea or trade.
Summary
To summarize, the Golden Cross and the Death Cross act as a confirmation of a trend that has already shifted between bearish and bullish. This confirmation can help you predict what will happen in the future. However, as with every indicator, the crosses are not a surefire way to predict the future. For both scenarios, false signals can and will occur. With that said, it is best to use the crosses in combination with other indicators to add valuable insight when making a trading decision.
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