By Kristoff De Turck - reviewed by Aldwin Keppens
Last update: Apr 27, 2023
The Golden Cross and Death Cross are popular concepts within the arsenal of tools in technical analysis. They are patterns created by combining two moving averages. You can read some basic knowledge about what moving averages are and what they can mean in a trading strategy in this article.
A moving average is a visual representation on a chart of the average price for the underlying asset over a predetermined period of time. So, an SMA(50) will thus represent the average price calculated over the last 50 periods. Those periods can be weeks, days, hours or even minutes, depending on the timeframe of the chart used. The chart below shows an SMA50 (blue line). This is the average price calculated from the closing price of the last 50 trading days.
The same chart with an SMA200 gives us the average price calculated from the closing price of the last 200 days.
Combining two such moving averages can be used to determine the trend of a stock.
A Golden Cross is created by the combination of two moving averages, namely the 50 and the 200SMA as shown separately on the charts above. The term itself refers to the time when the two averages cross. The moment the SMA50 intersects the SMA200 upwards, we refer to it as a Golden Cross. See the image below:
A Death Cross is just the opposite. It refers to the moment when the 50SMA intersects the 200SMA downward.
The moment the 50SMA crosses the 200SMA upwards and a golden cross is formed there is, from a technical point of view, a trend change from negative to positive. As long as the shorter average (the 50SMA) stays above the longer average (the 200SMA) the trend is positive. Only long positions are considered.
When the 50SMA crosses the 200SMA downwards and a death cross is formed, there is a trend change from positive to negative from a technical point of view. As long as the shorter average remains below the longer average, the trend is negative. Only short positions are considered.
In this way, the Golden and Death Cross can be used as a blueprint to chart trend changes.
In a long-term trend strategy the crossings can also be used as trading signals. The Golden Cross then serves as a trigger for a long position, the Death Cross is the initiation of a short position. Of course this technique is not flawless. In a market where buyers and sellers keep each other in balance you will be confronted with false crossings more than once by applying such a strategy. The example chart of Cincinnati Financial (ticker:CINF) below makes it clear what we mean by this.
As shown in the chart above, the moment the crossing happens at a Golden or Death Cross, the trend change has been going on for a while (the green and red arrows). This is because both moving averages are created by interpreting information from the past. We therefore speak of delayed indicators. It is important to keep in mind that in principle no predictive value can be attached to them. Crossings are a confirmation of an already existing trend. So if the market moves sideways, you get a series of Golden as well as Death crosses.
It should be obvious that automatically buying at a Golden Cross and selling at a Death Cross is not a good idea. They mainly play a role in confirming a recent trend change. In combination with other elements, they can thus be part of a specific trend strategy. more on that in a later article.