Golden crosses and death crosses sound like dramatic,
fortune-altering moments from a medieval-themed board game.
However, when it comes to stock trading, the death cross and golden cross are a bit less dramatic.
Both long-term as well as swing traders can use golden and death crosses to identify
trends and potential entries and exits. You just need to know how to use them.
A golden cross occurs when a security or index’s 50-day moving average
crosses above its 200-day moving average. This means
the recent average price is higher than its longer-term average price,
so it’s often considered a bullish signal that could indicate the continuation of an uptrend.
A death cross is just the opposite. It occurs when the 50-day moving average
crosses below the 200-day moving average, so it’s often considered a bearish signal.
Although golden and death crosses traditionally use 50- and 200-day moving averages, some traders
use different intervals depending on their time frame. The key is having one short-term and one
long-term moving average to compare a more recent average price to a longer-term average price.
Just keep in mind that the shorter the moving average time frame is,
the more sensitive it is to everyday price movements, which could lead to false positives or
quick back-and-forth reversals called whipsaws. Let’s look at an example of a golden cross. In
June 2020, Penn Gaming displayed a golden cross, and then continued in an uptrend through the rest
of the year. In this scenario, the golden cross could’ve served as a potential entry point.
On the other side of the coin, Chesapeake Energy displayed a death cross in December 2018
and that trend continued through December 2020.
In this scenario, the death cross may have been a good exit point.
However, using golden and death crosses as entry and exit points can come with risks. First off,
these crosses do not guarantee a trend will continue long term. Many bullish rallies start
with a golden cross, but not all golden crosses lead to rallies. The same goes for death crosses.
Look at Nike, which in 2020 displayed a death cross amidst the market reaction to the
coronavirus but then quickly displayed a golden cross. This is called a whipsaw, and it happens
all the time. Look at the year Pacific Gas and Electric had in 2020. It’s flip-flopped more times
than a playground seesaw. These false positives can be difficult to identify until after the fact.
Another risk that comes with using moving average crossovers like golden or death crosses is lag.
Because moving averages are based on historical data, it can take time for a new trend to appear
on a moving average. If a stock has been moving down for several months and then begins a new
uptrend, it can take weeks for the new higher prices to have much impact on the average.
By the time a golden cross or death cross appears, the new trend may be well underway, which means
missing some of the upside when getting in or experiencing some losses before getting out.
Going back to Penn Gaming, you can see that by the time it displayed a golden cross,
its price had already been on an upswing since the middle of March 2020.
It even displayed a death cross during that uptrend because the dip
caused by COVID-19 took some time to show up in these moving averages.
One way to reduce lag is to use moving averages with shorter time frames,
but like we discussed before, this may come at the cost of more false positives and whipsaws.
So while there could be an opportunity cost to waiting for the actual cross,
remember, the shorter the time frame, the less reliable it is.
So how can you be sure that a golden cross or death cross is reliable? Context is key.
One way is to be familiar with a stock’s previous price movement and news.
For example, following a death cross in November 2019, Anheuser-Busch InBev went on a sustained
downtrend until October 2020 when it displayed a golden cross. The cross was accompanied by
news of two new successful product lines, a positive earnings call, and news that the
company was eliminating its dividend in order to pay off debt, which was received positively.
All news indicated that things were looking up. Another way to know if a cross is reliable is by
looking at volume. A crossover accompanied by high volume suggests broader participation in the move,
which may mean a more reliable signal than one that occurs when there’s little volume.
Also, for every entry into a trade, make sure you’ve got an exit strategy.
Setting stops can potentially prevent you from losing big on trades while locking in wins.
There are also price patterns that can help confirm a golden or death cross,
like a double top or bottom. To help make better decisions, consider
using golden and death crosses in the context of other indicators like the relative strength index.
Whatever confirmation signals you decide to use, it’s important to have consistent rules to help
avoid analysis paralysis and manage emotions. To stay up to date on new videos,
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