Golden Cross: Reliable in Any Market
07/13/2011 6:00 am EST
The “golden cross,” or action of the 50-period moving average crossing over its 200-period counterpart, is a valuable odds enhancer for identifying and executing high-probability trades in all markets.
Many traders often ask me what the "golden cross" is. The actual definition of a golden cross is when a shorter moving average finally crosses a longer one, thus confirming a trend is intact. The definition that most traders are concerned with is the one where institutions and funds may start to take action, and therefore, start to drive a stock further into the trend with volume.
When looking at the markets, most of those large traders for funds are not going to be concerned with small, intraday fluctuations in the markets. Instead, they want to be on the right side of the longer-term trends and make profits for themselves and their clients.
In order to identify these trends, I have been told that many of them focus on the 50- and 200-day simple moving averages (SMAs).
Bounces of price on the 50- or 200-day simple moving averages can signal a buying opportunity for the fund trader, and there is evidence to support this, as you typically see prices accelerate away from those bounces with increased volume. However, if price closed below these points, it is usually a sign of weakness and lower prices to come.
So, the golden cross occurs when the 50-day SMA crosses above the 200-day SMA. That is the signal for most to start buying this extremely bullish stock. You will usually see an increase in volume and speed of the bullish trend, as many traders and investors alike all clamor for the opportunity to buy.
The smart trader should wait for a pullback, as the buying fury usually subsides quickly and offers a retracement and opportunity to buy at a discount.
Some innovative traders will also look to the inverse crossing of the 50-day SMA below the 200-day SMA as a signal for a shorting opportunity.
Once the 50 SMA moves below the 200 SMA, many traders and funds will lessen their exposure to that stock (read: sell). This can cause a sharp move to the downside. A patient trader can wait for a retracement and the ability to short at higher prices.
Obviously, this will not work every time or in every security. However, when combined with your knowledge of supply and demand zones, you can use the golden cross as an odds enhancer to locate, plan, and execute higher-probability trades in the equities markets.
By Brandon Wendell, instructor, Online Trading Academy