A golden cross is a technical indicator that investors use to predict bullish market momentum. A golden cross forms when a security's short-term moving average rises above its long-term moving average.
There are three separate phases to a golden cross pattern. The first involves the security in question hitting the bottom of a downward trend as selling activity dries up. Next, the short-term moving average surpasses the long-term moving average, signaling both a breakout and new trend. In the final stage, the security enjoys a sustained upward trend and continued gains. When the security falls back, its moving averages act as support.
Investors can use many different moving averages when looking for golden crosses. These moving averages could span weeks, days or minutes. However, they should keep in mind that longer moving averages frequently signal rallies that are longer and stronger. For example, an investor could look for a golden cross using a 15-day and 50-day moving average, but this might reveal smaller rallies than using a 50-day and 200-day moving average.
Even so, some investors use golden crosses during intraday trading in an attempt to profit from short-term fluctuations. In this instance, they might use moving averages of 15 and 50 minutes to reveal bullish sentiment.
Concerns About Reliability
Some market observers have expressed concerns about the reliability of the golden cross. Some research into this crossover pattern has shown it to be an ineffective predictor of future bull markets, at least in the short term.
After a short-term moving average surpasses a long-term moving average, the market could rise, but it might also fall, at least during shorter periods. The Standard & Poor's 500 index experienced 23 golden crosses between 1973 and May 2016, gaining an average of only 1.31% in the 30 days following the crossover. However, when examined during the year following the golden cross's appearance, the index enjoyed gains of more than 11%.
Confirming The Golden Cross
Investors have a few tools they can use to help confirm the information they receive from the golden cross. One method involves using additional momentum indicators, such as the relative strength index or the moving average convergence divergence (MACD). These tools can help provide insight into whether the security being studied is either overbought or oversold.
Another way investors can confirm trends is by looking at trading volumes, as high volumes can help reinforce the likelihood of a coming bull market. Armed with these tools, investors can make better-informed decisions about when to enter and exit positions.
Investors can use the golden cross to predict strong market sentiment. In some instances, the crossover pattern can help them identify the next bull market. However, investors should keep in mind that the signal is far more likely to be accurate over the long-term, and they can use both trading volume and also other technical indicators to help confirm bullish market momentum.
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Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…