What is a Golden Cross?
A Golden Cross is a basic technical indicator that occurs in the market when an asset’s short-term moving average (50-day) rises above a long-term moving average (200-day). It signals a bullish turn in sentiments. In other words, the shorter-term MA rises faster than the longer-term until it catches up with the latter. This movement shows the stocks are breaching the support levels of long-term MAs to make new highs. A moving average is the average of closing prices of shares over a given period.
Why does A Golden Cross Indicate Bullishness?
Experts maintain that if short-term MA prices breach the long-term moving averages and stabilize, the stock could gain 5-7 percent. In a golden cross chart, you will see the eventual bottoming out of stock prices before they start soaring upwards and steady above the long-term moving average.
This stabilizing effectively indicates investors are bullish about stock prices and expect prices to remain at similar levels or rise further. In a golden cross, the long-term moving average turns out to be the support level for the prices, and the golden cross remains as long as the prices trade above the long-term moving average. Positive sentiment about a particular stock increases investor interest and builds buying opportunities at those levels. As the two trend lines align and as long as short-term MA cruises above long-term MA, experts suggest the bullish sessions will likely last for some time. As the trading volume rises, the upward trend in stock prices gathers steam. But when the short-term moving average moves below the support level, it gives way to a new technical chart pattern called the death cross.
The purpose of moving averages is to indicate the bullish markets from the bearish ones. When markets are bullish, as indicated by a golden cross, traders look to buy with the slightest dips in prices, and when markets are bearish, like a death cross indicates, buyers sell when prices spike even a little bit. This way, the golden cross and death cross work as trading strategies since traders can simply follow the trends indicated by these two technical chart patterns.
Drawbacks Of Golden Cross
More often than not, golden crosses have rightly predicted significant bull markets, but not always. It is quite possible that a golden cross may not sustain, in which case, if you take a long position relying on the golden cross alone, you may be in for some setback in the short run. So, similar trends in other indicators and filters must reinforce a golden cross before taking a trading position.
Limitations of Using the Golden Cross
All indicators are “lagging,” and no indicator can 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, a golden cross should always be confirmed with other signals and indicators before putting on a trade.
The key to using the golden cross correctly—with additional filters and indicators—is always using proper risk parameters and ratios. Remembering to always keep to a favorable risk-to-reward ratio and time your trade properly can lead to better results than following the cross blindly.
Conclusion:
To make a better decision following a golden cross, you can look at a stock in a current golden cross with a long downtrend before bottoming out and rising again. When a stock enters a golden cross after having seen multi-years of a bearish death cross, it can be a strong sign of trend reversal. Yet another option is to look for a double bottom; that is, the stock on both the moving averages breaches the same lows before moving into a golden cross. Once the golden cross is formed, wait for the prices to test the long-term moving average as support levels. Then you can know fairly well how strong the rally predicted by the golden cross will likely be.
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