Hang around traders and you will hear people talking about the “golden cross” and how it’s a bullish sign.
But it’s only that kind of sign if you know what you are looking for and how to spot it.
The golden cross is the point — when plotting simple moving averages — that the short-term moving average crosses above the longer-term averaged. Generally speaking, a golden cross pattern involves three stages.
First, look for a long downtrend with the stock bottoming out at one point and building some resistance. Next, in the second stage, you should notice the short-term moving average cross above the longer-term moving average, indicating a potential trend reversal, with bullish trading in the cards. Finally, in the last stage, the stock should build momentum to the upside.
After that point, if you get long the stock, you can watch the short-term and longer-term moving averages for areas of support; moreover, if the shorter-term moving average crosses back below the longer-term moving average, it could indicate another flip in the trend — with bearish trading ahead — so that you might want to exit.
What to Look For
There are no hard rules for the golden cross. You don’t need to use a specified periods for the moving averages. However, swing traders and longer-term investors often use the 50-period and 200-period moving averages. On the other hand, short-term traders might look to use 3-period and 8-period moving averages.
If longer period moving averages are used, the stock might need some time to build bullish momentum, but these tend to form stronger breakouts and uptrends. Conversely, if shorter period moving averages are used, the price could quickly build momentum, but these might be weaker breakout and uptrend signals.
Let’s take a look at some examples.
Regeneron Pharmaceuticals Inc. (REGN) formed a golden cross pattern, when the 50-day simple moving average crossed above the 200-day simple moving average.
In the chart above, the downtrend stage and the bearish trading are plainly visible. Ultimately, the stock bottomed out, and formed a wedge. Thereafter, the stock broke above the upper trendline, and the 50-day moving average crossed above the 200-day moving average. The stock reached some resistance area, so if REGN has a clean break above the $442 level, it might continue to build a momentum. Consequently, this is a potential trading opportunity.
Looking at short-term trend lines, here’s a golden cross in Facebook Inc. (FB).
If you notice, FB had a short-term downtrend, but bottomed out. Thereafter, the 3-day exponential moving average crossed above the 8-day exponential moving average, as shown in the circled area. This indicates a potential short-term or swing trade, on the long side, and bullish trading. Notice how the trade materialized and you could have profited from it.
The golden cross can be a powerful trading tool when used to spot potential entries on the long side. Do your homework to make this pattern ingrained in your memory, and use it in conjunction with other high-probability setups, but remember that these patterns don’t always work out. You’ll need to properly manage risk, because there are times when the golden cross occurs but the stock fails to build the bullish momentum to profit from the technical pattern.