The golden cross occurs when are relatively short-term moving average crosses above a long-term moving average and may be a strong signal of a bull market.
Traders can adjust the moving averages, but the default values are 50 days for short-term and 200 days for long-term moving averages.
In contrast, a death cross occurs when the short-term moving average crosses below the long-term and signals a bear market.
Understanding Golden Cross
The golden cross is a well-known bullish signal that occurs when a relatively short-term moving average, which reflects recent prices, crosses above a long-term moving average, which is the longer-term trend.
It means that the short-term price level is higher than the longer-term price level, which indicates that recent sentiment around an asset's price is optimistic, especially when accompanied by high trading volumes.
Commonly used parameters for the golden cross are the 50-day moving average (DMA) and the 200-DMA for the short- and long-term moving averages respectively. Traders can also adjust the moving averages assumptions based on different time frames.
The Golden Cross can be applied to trading both individual securities and market indexes such as the Dow Jones Industrial Average (DJIA).
There are three stages to a golden cross:
In the first stage, a downtrend exists and eventually bottoms out because selling interest is gradually overpowered by stronger buying interest.
In the second stage, a new uptrend emerges whereby the short-term average crosses above the long-term average, forming a Golden Cross.
Finally, the new uptrend is prolonged and, with continuing gains, a bull market is confirmed. As long as both stock price and the 50-day average remain above the 200-day average, the bull market is considered intact.
Each moving average line (MA) is formed by calculating the average price over a specific period and using those points to visually smooth price action. For example, for a five-day moving average, the average of each five-day subset is calculated, and then a line is drawn that connects those data points.
How to use a golden cross
The golden cross has been a popular trading signal among technical traders. It is widely viewed as one of the most common bull market signals and, therefore, a strong buy signal.
If you are a long-term investor and prefer to buy and hold, the golden cross could still serve as a timing signal, telling you when to enter the market.
If you are a technical trader and prefer high-frequency trading, you can strategize to buy an asset when a golden cross occurs and then sell it when a death cross occurs.
A death cross is the exact opposite of a golden cross. This popular bearish indicator occurs when a short-term moving average (usually the 50-day), crosses beneath a long-term moving average (usually the 200-day). While a golden cross may serve as a positive signal to enter the market, a death cross can help indicate good times to exit the market.
It is important to remember that a golden cross doesn't guarantee the market will rise. Other indicators such as the relative strength index (RSI) or moving average convergence divergence (MACD) are often used in conjunction to confirm the trend indicated by the golden cross.