Defining the golden cross
Technical traders take their time in analyzing chart patterns to make sound trading decisions. Some charts give signals that help traders develop trading ideas. This includes the golden cross chart pattern. When a considerably short-term moving average goes over long-term moving averages, golden cross chart patterns will give a bullish signal.
Moreover, these chart patterns are specifically bullish breakout patterns that appear whenever a crossover involves a security’s short-term moving average that breaks above the long-term moving average or resistance level. When we say short-term moving average, we can be talking about moving averages of days. On the other hand, when we say long-term moving average, we can be referring to a moving average of 50 days. Long-term indicators carry heavier weight compared to others. Hence, when a golden gross chart pattern enters the picture, we might as well expect a bull market strengthened by high trading volumes.
There are three stages involved in a golden cross chart pattern. Let us explain them further:
- First stage. Selling is almost out of the picture, if not totally out. Hence, the downtrend should bottom out.
- Second stage. The shorter moving average starts to make a crossover over the larger one, triggering a breakout and trend reversal confirmation.
- Final stage. The uptrend continues.
What are death crosses?
If there is a golden cross, its opposite is the death cross. The moving averages that we mentioned earlier stand as the pullbacks’ support level until a crossover backs down that a death cross develops. Death crosses are chart patterns where the shorter moving average crossovers below the longer one.
Moving averages and time
Moving averages have different periods, and every period stands for specific time frames. If the time period is more significant, the breakout is stronger. Traders commonly use the 50-period and 200-period moving averages. For day traders, they prefer using smaller periods when they trade golden cross breakouts on a single trading day. These short time-period moving average examples include the 5- period and 15- period moving averages. If a trader changes his mind, he can adjust the time period from minutes to days, weeks, or even months. Again, the bigger the period, the stronger the golden cross breakout.
The downsides of golden crosses
Just like any indicator, golden crosses can also produce false signals. So, it is essential to confirm and double-check. It is better to incorporate more tools than relying on the golden cross alone before entering a trade. Use risk parameters and ratios, and time your trade correctly. Keep a good risk-to-reward ratio.
Let us cite an example.
Let us assume that we have two golden crosses with 50-period and 200-period moving averages. The first one’s crossover is for one week, and the other is for an hour. Which among the two is the stronger? As we have mentioned earlier, the more extended the time period is, the stronger the golden cross. Hence, the weekly one is stronger compared to the hourly golden cross.
Traders may know whether the uptrend is overbought or oversold using momentum oscillators with the golden cross breakout signals. These momentum oscillators include the MACD, RSI, or stochastic. If we do this, we can get a better view of the best entries and exits.