What is the Golden Cross in stocks?

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Stock analysts and investors often use charts and patterns to determine how the market is moving and the changes that might be there soon. The golden cross is one of such charts that are used by investors and analysts, and it is something they are quite optimistic about. So let’s take a closer look at the golden cross meaning and what it entails. 

What is a golden cross?

As we mentioned above, the golden cross is one of the chart patterns used to analyse and study the market for changes. It is a chart pattern where the short-term moving average of a stock or security crosses the long-term moving average. So it is a crossover and a really positive point for all stock investors. The short-term moving average is an average of ~50 days of movement, while the long-term moving average is ~200 days. A moving average is the average of closing prices of shares over a given period.

If we assume that each day is weighted evenly, then the crossover of a 50-day and 200-day moving average is the exact point where the average price of a stock over the last 50 days goes above its average price over the last 150 days prior to that. This means that the golden cross is a comparison between the recent price of 25 days ago and the slightly older price of 125 days ago.

What are the 3 stages of a golden cross?

A golden cross chart has three stages:

  • In the first stage, there is a downtrend of stock prices.
  • The second stage is where the downtrend breaks, as the short-term moving average crosses over a long-term moving average. 
  • In the third stage, there is a continuous uptrend where the stock prices rise. But stage 3 also might not happen if the first two have already taken place.

How is a golden cross formed?

The golden cross chart indicates momentum. T

This means that prices of stocks are continuously increasing. But initially, there is a downtrend in the prices, which is the first stage. After the downtrend, it eventually bottoms out and reaches a point where buyers overpower sellers. The second stage is where the crossover happens, where the short-term moving average crosses the long-term moving average. This triggers a breakout and changes the course of the downtrend. There is a final stage where after the crossover, the uptrend continues. 

In golden cross charts, the 50-day and 200-day moving averages are the ones that are most commonly used. As a general trend, larger periods of time lead to stronger and longer lasting breakouts. But day traders use much smaller moving averages, like the 5-day and 15-day periods, in order to trade intra-day golden cross breakouts. Other traders use different periods of time based on their trading preferences and practices. 

Limitations

The first and the foremost limitation is that, to truly make a profit in the stock market, there is a lot more you will need than charts in order to be able to analyse market patterns correctly. You might still suffer huge losses even if you have all the right strategies in place. That is because the market is volatile and nobody can predict its trends and performances. Only when you are informed about the worldly affairs and what’s going on, will you have an idea of how it is going to affect the market.

Golden cross charts can only tell you about the past. There is no pattern that can give an accurate prediction of the future. In fact, even when the golden cross reflects the recent past, it might still be affected by a bunch of factors. When your analysis is limited to the most recent data, you are restricting your insight and analytical skills to a shorter period of time. As a general rule, if you want more accuracy, you will have to accept more lag. 

Investors use other techniques as well in addition to the golden cross chart pattern before making an investment decision. So just the golden cross alone is not enough to make sustainable investment decisions. 

Also Read: Factors Affecting Share Prices

Conclusion

In conclusion, the golden cross is a reliable tool. Because of the lag in this indicator, a golden cross can be identified only after there has been a rise in the market, which proves that it is a reliable indicator. All in all, investors and stock analysts believe that a golden cross in the market is the confirmation that the downward trend has reversed. So the hack to using the golden cross correctly is to use it with other tools and indicators. You can use profit targets, stop loss, and other risk management tools in order to make correct use of the golden cross. You have to maintain a favourable risk-to-reward ratio and time your trading instead of just depending on the golden cross to make an investment decision. 

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