This indicator has remained in focus over the last two weeks – internationally first, due to movements in certain Cryptos and domestically due to the Reliance Industries price movement around 28 June when this signal formed and people started discussing a 10%-15% move ahead.
So what is the Golden Cross and what does it portend for the stocks displaying such movements?
Identification of Trends
The most important aspect in investing is to correctly identify the long-term trend. Once this is done, and the direction of the trend is firmly established in one’s mind, all one needs to do is look for buying opportunities in an uptrend and selling opportunities in a downtrend.
Without a guide based around certain indicators, traders may confuse the process by waiting for lower levels to buy in a bull market and missing a large portion of the rally or buying when the trend has reversed which usually results in losses.
This is where the Golden Cross pattern comes in.
What is the Golden Cross?
There are numerous chart patterns and technical indicators that traders and investors use in their analysis of the financial markets, however, the one pattern that most market participants are familiar with is the Golden Cross!
A golden cross is a simple setup that forms when a faster period moving average, usually the 50-day simple moving average, crosses above the longer-term moving average, generally the 200-day SMA.
In a price downtrend, both the 50-day SMA and the 200-day SMA are sloping down. However, when the price reaches an attractive level, long-term investors start accumulating, which arrests the pace of the decline. As more investors start buying, the trend starts to flatten and then turn up.
A sustained up-move results in the 50-day SMA changing its direction from down to up. However, the 200-day SMA is slower to respond, hence when it is either falling or has flattened out, the 50-day SMA rises above it, forming the golden cross. And that’s when the noise starts! When a golden cross forms, it is a sign that the downtrend has ended and a new uptrend could have begun.
Evolution of Prices
There are generally three stages to a golden cross:
- Bottoming : In the first stage, there must be a pre-existing downtrend that starts to bottom out as selling pressure is suppressed with new demand and prices begin to revese and rise.
- Cross: In the second stage, the market creates a new uptrend in the form of a breakout back above the long-term moving average. This breakout is confirmed when the short-term moving average crosses back above the long-term moving average.
- Pullbacks: After the golden cross occurs, both of the moving averages will tend to act as support on pullbacks to continue the bullish momentum until the market eventually breaks back below them to form a death cross which signals the start of a potential bear market.
Inexperienced traders may often feel that the price has run up too fast and would wait for a deep correction to happen before buying. However, when a trend changes, it rarely gives an opportunity to buy at much lower levels as was the case here. That’s where the DMAs come to your support to indicate to you where the long term averages rest.
The above Nifty chart shows how 3 (Green) Golden Crosses occurred over the last 3 years followed by sharp rises in two instances (note RSI : The first and last one showed oversold and followed with a cross) and one very delayed price signal (prices didnt move much higher but at that time RSI was already pretty high)
More importantly note how the 200 DMA acted as support on pullbacks and took support so if there was a golden cross formed, RSI was rising and support wasnt broken, one would have stayed invested all through from 10800 odd levels right upto now.
A Word of Caution
As with all technical indicators, the golden cross is considered to be a lagging indicator – meaning that signals will form only after certain lengthy price action develops. And one could be caught in whipsaws.
Note that the Golden Cross is considered more of a signal than an actual trading strategy so the best way to use the golden cross to trade is to combine it with other qualifiers such as market structure, momentum indicators and/or candlestick patterns. RSI/MACD and of course fundamental valuations could help here to understand the risk return potential.
Traders could also avoid buying if the golden cross forms when the 200-day SMA is still sloping down. One can wait for the 200-day SMA to flatten out or turn up before buying as that may reduce the whipsaws.
Once the uptrend is established after the golden cross, traders may look for buying opportunities and stay with the trend till a reversal is signaled.
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External Resources for Golden Cross
Image and article originally from www.plindia.com. Read the original article here.