A golden cross is a chart pattern in which a relatively short-term moving average crosses above a long-term moving average. The golden cross is a bullish breakout pattern formed from a crossover involving a security's short-term moving average (such as the 50-day moving average) crossing above its long-term moving average (such as the 200-day moving average) or resistance level.
As long-term indicators carry more weight, the golden cross indicates the possibility of a long-term bull market emerging. High trading volumes generally reinforce the indicator.
How Does a Golden Cross Form?
The golden cross is a momentum indicator, which means that prices are continuously increasing-gaining momentum. Traders and investors have changed their outlooks to bullish rather than bearish. The indicator generally has three stages.
The first stage requires that a downtrend eventually bottoms out as buyers overpower sellers. In the second stage, the shorter moving average crosses over the larger moving average to trigger a breakout and confirms a downward trend reversal. The last stage is a continuing uptrend after the crossover. The moving averages act as support levels on pullbacks until they cross back down.
The most commonly used moving averages in the golden cross are the 50-day- and 200-day moving averages. Generally, larger periods tend to form stronger, lasting breakouts. For example, the 50-day moving average crossover up through the 200-day moving average on an index like the S&P 500 is one of the most popular bullish market signals.
Day traders commonly use smaller periods like the 5-day and 15-day moving averages to trade intra-day golden cross breakouts. Some traders might use different periodic increments, like weeks or months, depending on their trading preferences and what they believe works for them.
But when choosing different periods, it's important to understand that the larger the chart time frame, the stronger and more lasting the golden cross breakout tends to be.
Example of a Golden Cross
The image below uses a 50-day and a 200-day moving average. The 50-day moving average trended down over several trading periods, finally reaching a price level the market couldn't support. The 200-day moving average flattened out after slightly trending downward.
Prices gradually increased over time, creating an upward trend in the moving 50-day average. The trend continued, pushing the shorter-period moving average higher than the longer-period moving average. A golden cross formed, confirming a reversal from a downward trend to an upward one.
Notice that the price range of the candlesticks made a significant jump when the downward trend bottomed out and turned into an uptrend. Something likely occurred that changed investor and trader market sentiments at this time. The candle bodies were large (the difference between open and close prices), and more days closed with prices much higher than opening during the first uptick after the 50-day moving average bottomed.
Limitations of the Golden Cross
All indicators are “lagging,” which means the data used to form the charts has already occurred. This means that no indicator can truly predict the future. Many times, an observed golden cross produces a false signal. Despite its apparent predictive power in forecasting prior large bull markets, golden crosses also regularly fail to manifest. Therefore, other signals and indicators should always be used to confirm a golden cross.
Source: Investopedia, Golden Cross Pattern Explained With Examples and Charts, accessed 28 December 2023, <https://www.investopedia.com/terms/g/goldencross.asp>