Opinions are divided on its merits of technical analysis (TA) but, for many investors, TA of share price movements is a vital tool in deciding when to buy and sell stocks. Amongst the best known indicators used by the technicians is the Golden Cross. Despite its popular following, there has been surprisingly little research on whether the golden cross actually works and what it really tells the investor. As it turns out, there is money to be made through Golden Crosses – but not necessarily in the way that many chartists think.
What is a golden cross?
To understand a golden cross, first you have to get to grips with the idea of moving averages. A moving average takes the closing price of a stock from each of the previous days over a given period (say 50 days) and then divides it by the same number (50) to arrive at an average. As each day passes the entire data set is updated, which is what makes this a ‘moving’ average. Investors like this calculation because it strips out the intra-day volatility of a share price ("noise") to give a fixed trend that can be tracked over a given time frame.
On a stock chart, the golden cross occurs when the 50-day MA rises sharply and crosses over the 200-day MA. This is seen as bullish. According to Joseph Granville, a famous technician from the 1960’s (who set out 8 famous rules for trading the 200-day MA), a golden cross can only occur when both the 50-day and 200-day moving averages are rising. Others takes a less stringent view on this.
Usually, a golden cross is associated with sharp upward price movement and can be used as a buy signal in the belief that a significant uptrend will follow. The reverse of this event is known as a Death Cross where the 50-day MA falls below the 200-day MA, a bearish signal.
A related theory is the idea that, if the 50-day MA is much higher than the 200-day MA (which happens with a fast run up in price), the stock is likely to be temporarily overbought (therefore, overvalued) which is bearish for the short-run.
All that glitters is not gold?
Many traders swear by the efficacy of the golden cross based on their anecdotal experiences but, as regular readers will know, we believe in evidence rather than instinct-based…
