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The golden cross pattern is a technical indicator that appears when a security’s short-term moving average rises above its long-term moving average. A golden cross is generally interpreted as the sign of an upcoming market rally.
The golden cross pattern is a momentum indicator, and it tends to be popular because it is easy for chart watchers to spot and interpret. It doesn’t occur as often as other chart patterns, but when it does it sometimes even makes news headlines because it is a strong bullish indicator for a stock or an index.
How Do Golden Cross Patterns Form?
The golden cross candlestick chart pattern happens when the short-term moving average (e.g. the 50-day moving average) moves above and crosses a long-term moving average such as the 200-day moving average, or DMA.
It is an indicator that the market will probably head in a bullish direction, and can be used by stock investors, day traders, swing traders, options traders, or anyone interested in analyzing price movements.
A moving average is a graph of the average value of a stock price for some trailing period of time. Commonly used moving averages are the 50-day moving average (DMA) as a short-term measure and the 200 DMA as a long-term measure.
That said, traders can use moving averages of various lengths, from hours to months, to capture a desired time frame.
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3 Stages of a Golden Cross
There are three stages that form the Golden Cross pattern:
1. Downtrend. The first stage of the golden cross happens before the moving average lines cross. A downtrend occurs, and the short-term average is lower than the long-term average, but then buyer volume starts exceeding seller volume.
2. Breakout. Next, the cross happens. The short-term moving average crosses over and above the long-term moving average, reflecting a reversal of the downward trend and upward momentum.
3. Upward momentum. The trend continues and the prices continue to rise, with both the short- and long-term DMAs creating support levels (the lower end of both average prices) and indicating movement toward a bullish market.
Understanding support and resistance levels is key to reading technical charts. Support indicates where the price tends to stop falling; resistance indicates where the price tends to stop rising.
What Does a Golden Cross Tell Traders?
When the short-term average is higher than the long-term average, this means that short-term prices are rising compared to previous prices, showing bullish momentum.
The candlestick pattern that’s opposite the golden cross is the Death Cross chart pattern, which is when the short-term average moves below the long-term average, indicating a bearish market trend.
You can think of the golden cross pattern as a logical example of how price momentum can work. Because it’s the short-term DMA that rises and crosses the long-term DMA in a stock chart, it makes sense that analysts would interpret this as a bullish indicator that could have some staying power, as the short-term DMA would eventually play into the long-term DMA.
How Does a Golden Cross Work?
A golden cross occurs in a technical chart when the short-term moving average dips down to its resistance level, and then moves upward, crossing the long-term moving average.
Traders can use different time periods when conducting technical analysis, but the use of the 50-day moving average and the 200-day moving average are common when it comes to identifying the golden cross pattern. The longer the time period, the more lasting the upward trend may be.
Different traders, for example day traders or options traders, can use shorter periods, depending on when they’re aiming to place trades and what their strategy is.
Pros and Cons of Using the Golden Cross
The golden cross can be a useful technical pattern for traders to use to spot changes in market trends. However, on its own it has some limitations.
Benefits of the Golden Cross
The golden cross is known as one of the strongest bullish technical indicators, and can reflect other positive underlying factors in a particular stock.
Furthermore, since the pattern is so widely known, it can attract buyers, thereby helping to fulfill its own prediction.
Drawbacks of the Golden Cross
Like any chart pattern, there is no guarantee that prices will rise following the golden chart pattern.
Chiefly, the golden cross is a lagging indicator. It shows historical prices, which are not necessarily an indicator of future price trends.
Even if prices do rise, they might not rise for long after the golden cross forms.
Due to these uncertainties, it is best to use the golden cross in conjunction with other indicators.
How to Trade a Golden Cross
Both long-term and short-term traders can use the golden cross to help them decide when to enter or exit trades. It can be used both for individual stocks and for trading market indexes.
Most traders use the golden cross and Death Cross along with other indicators and fundamental analysis, such as the relative strength index (RSI) and moving average convergence divergence (MACD).
RSI and MACD are popular indicators because they are leading indicators, potentially providing more real-time information than the golden cross pattern.
What Time Frame Is Best for a Golden Cross?
The most popular moving averages to use to spot the golden cross are the 50-DMA and the 200-DMA. However, day traders may also spot the golden cross using moving averages of just a few hours or even one hour.
Whatever the chosen time period, traders enter into the trade when the short-term average crosses over the long-term, and they exit when the price reverses again.
Because the golden cross is a lagging indicator, investors enter a trade when the stock price itself rises above the 200-DMA rather than waiting for the 50-DMA to cross over the 200-DMA. The logic being: If traders wait for the pattern to form they may have missed the best opportunity to enter into the market.
Short sellers may also use the golden cross to determine when the market is turning bullish, which is a good time for them to exit their short positions.
The Takeaway
Chart patterns are useful tools for both beginning investors and experienced traders to spot market trends and find entry and exit points for trades. The golden cross is one indicator that technical analysts might use to determine whether a stock or market is bullish.
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