About Golden Cross Stocks in Detail

A technical trader may implement different technical tools and indicators and analyze different patterns on an asset’s price chart before making a trade-related decision. Among the several indicators out there, the moving average indicator is perhaps the most popular one. The moving average is easy to use and an easy-to-understand indicator. Due to this, the moving average is likely to be the first indicator a trader may explore when they start learning about indicators. However, a trader may start using multiple moving averages measuring different time periods with time. This is because using multiple moving averages can give stronger trade signals. Two more or more moving averages running on a price chart, measuring different base periods, can form different trading patterns. 

Golden Cross: Explained

A golden cross is a technical chart pattern that forms when a short-term moving average crosses above a long-term moving average. This crossover indicates a potential bullish trend is up the horizon. It is common to see traders use the 50-day moving average as the short-term moving average. Whereas the 200-day moving average makes up the long-term moving average. However, no such hard and fast rule exists, and a trader is free to use moving averages measuring different periods. The trader should only see to it that the long-term moving average has a weightage significantly higher than the short-term moving average. Traders can apply the golden cross to stocks, indices, and other financial assets in the stock market. 

Three Stages of a Golden Cross

The golden cross has three specific phases. In the first phase of the cross, an existing downtrend needs to bottom out. This indicates that the selling pressure is phasing out as a new wave of buying interest starts building. In the second phase, a trend reversal plays out. That is, an uptrend emerges as the buying pressure overwhelms the selling pressure. The short-term moving average cuts above the long-moving average below and signals a breakout. This crossover forms the golden cross. The breakout paves the way for a long uptrend in the third and final phase. 

Using The Golden Cross to Trade

Since the golden cross is a bullish indicator, traders and even investors primarily look for a golden cross formation for a buy signal. The cross forms only after the shorter moving average cuts over the longer moving average, so ideally, the trader should take an entry after the crossover. However, many traders opt to take an entry before the shorter average crosses over the longer average. This is because the golden cross lags behind the price, especially if the price action is showing high momentum. In simple terms, the price may often run upwards before the golden cross forms on the price chart. 

However, once the golden cross successfully forms, the price action is likely to go through a long uptrend. In this bullish phase, both moving averages that form the golden cross are below the price action and act as support lines. As long as the price and the shorter moving average remain above, the longer moving average, the bull run prevails. On the other hand, short-sellers may use the golden cross to sell or exit their short positions. A larger difference between the long-term and short-term moving averages results in a stronger potential uptrend post the golden cross. Likewise, a golden cross formed on a longer time frame price chart is more likely to lead to a strong breakout. 

However, depending on the style of the trader, the trader may use different moving averages of different lengths for the short-term moving average and the long-term moving average. For instance, an investor may refer to a yearly chart of a financial asset. They are likely to opt for the conventional practice of setting the short-term moving average to 50 days. While they set the long-term moving average to 200 days. On the other hand, an intraday trader will refer to shorter chart time frames. They are likely to refer to a daily chart or a weekly chart. In this case, they may opt for setting the shorter moving average to 10 or 20 periods. Whereas their longer moving average may rarely exceed 50 periods. 

The Difference Between a Golden Cross and a Death Cross 

A death cross is a pattern that is the polar opposite of a golden cross. While a golden cross acts as a bullish indicator, the death cross is a bearish indicator. The golden cross is a bullish signal that forms when the short-term moving average crosses the long-term moving average from below. As opposed to this, a death cross forms when the short-term moving average crosses the long-term moving average from above. The death cross indicates that a long bear market is approaching. 

After the formation of a golden cross, both the short-term moving average and the long-term moving average act as lines of support. In the case of a death, crossing the short-term moving average and the long-term-moving average acts as a strong resistance. However, in both cases, the longer-moving average is the more significant support or resistance. An uptrend, which was a result of a golden cross formation, will end with the formation of a death cross. Similarly, a death cross-induced downtrend reverses with the formation of a golden cross. 

Conclusion

The golden cross proves to be very reliable to confirm strong uptrends, especially to confirm trends of the larger uptrends. In the case of the Nifty 50 index, which is one of the benchmark indices in the Indian stock market, the formation of a golden cross between the 50-day moving average and the 200-day moving average has led to some of the longest bull runs. However, the golden cross lags behind the price action as an indicator to signal a buy or a long position. This lag is more severe compared to most other technical indicators.

At times, the golden cross can also give rise to false breakouts. The emergence of a false breakout is more common when the cross forms on a price chart analyzing a shorter time frame. Or when the difference between the periods of the two moving averages is considerably small. However, a good trader will also reform and implement other technical indicators into their trading strategy along with the golden cross. They will take the necessary means to mitigate their risk and will not just depend on a golden cross to carry their trades.