A golden cross is a bullish technical indicator in which a short-term moving average crosses above a long-term moving average.
Understanding the golden cross
Technical analysts look for a golden cross on price charts to identify a shift from a downtrend to an uptrend. Traders most commonly use the 50-day moving average as the short-term indicator and the 200-day moving average as the long-term indicator. When the 50-day line rises and intersects the 200-day line from below, the pattern is complete. This indicates that recent price action is stronger than historical price action.
The pattern develops in three stages. First, a downtrend bottoms out as selling pressure depletes. Second, the shorter moving average breaches the longer moving average. Finally, the uptrend continues, and the long-term moving average is a support level for future price drops. Elephants should note that the timeframes can be adjusted for different trading strategies, such as using hourly charts for day trading or weekly charts for long-term investments.
Because moving averages are lagging indicators, a golden cross confirms a trend reversal after it has already begun. The indicator does not predict future prices. False signals occur when a crossover happens but the price reverses shortly afterward. Traders often combine this pattern with other technical indicators like trading volume or the relative strength index to confirm the trend before entering a position.
Example
Imagine you are analyzing the stock chart for Elephant Tusk Care International, a company that manufactures tusk-polishing equipment for the global herd. The stock price declined steadily over the past year, dragging both the 50-day and 200-day moving averages downward. In recent weeks, strong earnings reports caused the stock price to climb.
As you review the daily chart, you observe the 50-day moving average flatten out and begin to rise. On Tuesday, the 50-day moving average crosses directly over the 200-day moving average. Trading volume is high during this session. You interpret this golden cross as a signal that the bearish trend is over. You decide to buy shares in Elephant Tusk Care International, anticipating that the new bullish trend will persist.