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The Golden Cross and The Death Cross

How to Use The Golden Cross and The Death Cross in Trading

The terms Golden Cross and Death Cross can evoke ominous thoughts of extreme gains or extreme losses in many traders. Thankfully that is not necessarily the case. Both of these trading signals can be potentially lucrative if you know how to trade them. Traders often use these indicators in conjunction with other short-term indicators to flag changing trends. Different traders have different opinions on the Golden Cross and Death Cross, which has prompted some lively discussions. So, how can traders use both these signals to their benefit?

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What is a Golden Cross?

In the eyes of many traders, the Golden Cross is the Holy Grail of bullish technical indicators. To flatten out short-term volatility, traders traditionally use the 50-day moving average and the 200-day moving average. When a 50-day moving average moves up through the 200-day moving average, they often see it as a confirmation of an emerging bullish trend. Mainly due to the lag on the two moving averages. In theory, it indicates short-term momentum and a potential change in trend direction.

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What Does the Golden Cross Tell You?

When you encounter a Golden Cross, it is safe to say that no two charts are ever identical. However, there are three distinct stages of the Golden Cross, which are:

Buyers taking control of a downtrend

By definition, due to short-term weakness in the 50-day moving average, a Golden Cross will occur after a downtrend. The resulting strength in the 50-day moving average comes about when the short-term sellers dry up and the buyers begin to take control. The chart will level out, and then buyers move into the driving seat, with the price moving higher.

Momentum moves the 50-day average through the 200-day average

This is the turning point. The 50-day moving average will eventually push up through the 200-day moving average if the upward momentum continues. This is the point at which the eyes of many traders will light up! Is this a new trend or a false flag?

Consolidation, then resume up trend

When the 50-day moving average moves sharply up through the 200-day moving average, it indicates strong momentum. Sometimes this can lead to short-term overbought situations. Technical charts often reflect these cases in periods of consolidation, sideways trading, or partial retracement. This is the key moment. If the asset price trend is changing, the buyers will eventually regain control, moving the asset price to higher ground.

Many traders make the mistake of buying too early. The critical error here is to buy before the uptrend has been confirmed and the period of consolidation is over. If you invest too early, you may encounter a pullback towards the 200-day moving average. This may lead to a retracement below the trendline. There is an easy way to tell what degree of risk traders are willing to take. It depends on whether they wait and see the trend’s confirmation after what they expect to be a consolidation period.

Example of a Golden Cross

Next, we will demonstrate a Golden Cross and how the trend may progress. To that end, we will use the E-Mini S&P 500 Futures as an example. Let’s look at the chart below. The green line (indicating the 50-day moving average) moved up through the blue line. The latter indicates the 200-day moving average) in July. At that point, the index went into a period of consolidation. Afterward, it briefly fell back below the 50- and 200-day moving averages. However, while the 50-day moving average remains above the 200-day moving average, we consider the trend intact.

As you can see from the shaded area, the index rebounded relatively quickly after dipping below the 200-day moving average. It was only in late October/early November that the Golden Cross was confirmed. While investors going long on E-Mini S&P 500 Futures would eventually have made money, buying any time during the period of consolidation, this would have been something of a gamble.

Example of a Golden Cross
Source: Finamark

Once we could confirm the change in trend towards the end of the area marked by the box, this resulted in a significant upward movement in the index. Even though this period of consolidation/sideways trading is perhaps more elongated than normal, it does highlight the various stages of a changing trend.

What is a Death Cross?

In simple terms, a Death Cross is the exact opposite of a Golden Cross. It indicates the weakening of a positive trend and the emergence of a bearish trend. Very often, due to growing short-term downward momentum, this can lead to a short-term oversold situation. It is not uncommon for the index level to rebound on or around the Death Cross date. Much like an overextended elastic band snapping back, this is all part of the Death Cross process. However, it can prompt some inexperienced traders to discount the signs of a potentially changing trend.

Example of a Death Cross

The following chart perfectly illustrates the various stages of an emerging downward trend. In particular, you should take a close look at the area in the box. As you will see, the index had been stuck in a trading range for some time before the sellers took control, pushing the index lower. Interestingly, the crossover period came just after a sharp sell-off. There was then a few days of consolidation, another sharp sell-off, and then another period of consolidation. 

Experienced traders would have waited until confirming the emerging downtrend towards the end of the shaded area. Yes, they would have missed some of the earlier downturns, but the trend would have, in their eyes, been all but certain. Consequently, this led to a 300+ point fall in the E-Mini S&P 500 Futures and a relatively quick recovery. The market reached its bottom at around 2340. The recovery was fairly strong. However, there was still more than enough opportunity to make a significant return on a short E-Mini S&P 500 Futures position.

Example of a Death Cross
Source: Finamark

How to Trade the Golden Cross and Death Cross

There are very few technical traders who would depend upon one technical indicator by itself. The above Golden and Death Crosses are prime examples of why it is dangerous not to consider other indicators. The swift rebound would have caught out many traders. That said, these two particular indicators have been impressively accurate when it comes to highlighting changing trends in E-Mini S&P 500 Futures. The following index chart, using 50-day and 200-day moving averages, perfectly reflects this:

How to Trade the Golden Cross and Death Cross

To offer a little more balance to the argument, on the whole, the period covered during this chart takes an extremely bullish time for the S&P 500 index. Sentiment as ever seemed to err on the side of optimism rather than caution.

Golden Cross Trading Strategies

As we mentioned earlier, very few disciplined technical traders will only consider one indicator when looking at their next investment. We know that the Golden Cross is a powerful buy signal once we can confirm the trend. However, how does this all fit in with a trading strategy?

When to commit to an investment

There are very few Golden Crosses or Death Crosses where short-term pullback and consolidation periods do not follow. The above chart is a good example of that. Traders will always look for confirmation the trend has changed rather than slipping back into the previous range, but at what point do you commit your investment?

Using additional technical indicators

As soon as you see a potential Golden Cross or Death Cross, it is worth looking at other technical indicators. Since these cross technical events are based on moving averages, they can be relatively late, albeit powerful, indicators of a changing trend. It may therefore be useful to take other technical indicators into account. Examples include the Stochastic Oscillator, Bollinger Bands, Moving Average Convergence Divergence, and the Relative Strength Index. That’s just to name but a few. 

Don’t forget stop-loss limits

While technical indicators are handy for those looking to trade short, medium, and long-term futures, it is still advisable to use stop-loss limits. Those looking to invest in a “new trend” before waiting to confirm it are taking a calculated risk. If the trend is confirmed, they will likely have more upside potential, taking a greater risk at a lower level. If the trend fades and the index reverts back to its previous trading range, a stop-loss limit would limit most downsides.

Those who successfully use the Golden Cross and Death Cross in their investment strategies tend to be flexible and ready to react to change. The more technical indicators that support a changing trend, the more you should go with that new trend. However, once the trend is confirmed, it is still not simply a case of buying futures and taking your eye off the ball.

Death Cross Trading Strategies

A Death Cross trading strategy can be useful when looking to protect a profit or take out a short position (or both). In reality, all of the options applicable to a Golden Cross trading strategy are relevant to an emerging Death Cross trend. The only difference is that the trend is moving in the opposite direction. However, some experts have made an interesting observation about the Death Cross. 

In general, the majority of investors tend to take a more optimistic outlook in the longer term. Consequently, when a sharp downtrend emerges, many investors will be looking to “bottom fish” on oversold positions. As a result, we often see a short sharp rebound from oversold positions. This is typically is stronger than the pullback from an overbought position. 

While this is a contentious issue with many investors, skeptics also highlight that sometimes Death Cross trading signals may not be as strong as their Golden Cross counterparts. As an investor, do you tend to look on the upside in the medium to long term? Or are you a realist who appreciates both upward and downward trends in equal measures?

Comparing The Golden Cross vs Death Cross

The concept behind a Golden Cross and a Death Cross is almost identical. The main difference is one is an uptrend, and the other is a downtrend. In theory, there is no reason why either of these respected indicators should be any stronger than the other. However, as we touched on above, on the whole, investors tend to be more upbeat than downbeat, especially in the medium to long term. Even if there are difficult short-term scenarios where markets come under pressure, it is difficult to see any potential upturn. The coronavirus pandemic is a prime example of investors/markets looking to be positive but often finding few reasons to break free from the ongoing skepticism and negative sentiment.

When it comes to trading based on using technical indicators, it is important to stay disciplined. History shows that investors will take profits quicker than they cut their losses. The idea of banking a profit is attractive and brings with it a degree of kudos. The idea of cutting your losses, admitting you were wrong is something that many investors struggle with.

The whole idea of technical analysis led trading is based on making interpretation while assessing probabilities. There will always be a degree of flexibility regarding how you evaluate emerging trends. However, the necessary discipline is something that comes with time and experience. If a trading strategy using technical analysis works in theory, then it should work in practice. However, dealing in real-time with real money brings a whole host of different pressures!

Criticism of the Golden Cross and Death Cross

As Ari Wald, head of Technical Analysis at Oppenheimer & Company, once said:

All big rallies start with a Golden Cross, but not all Golden Crosses lead to a big rally.”

This short sentence says everything about the Golden Cross’s risks and, by extension, the Death Cross. Those who jump in too early before a new trend is confirmed are taking a higher risk, albeit for a potentially higher return. As with any technical analysis type, there will be false flags, and there will be challenges. While many investors prefer to look for “complex” technical triggers, it is important not to ignore good old-fashioned stop-loss limits. 

If you act too quickly before the trend has been confirmed, at least you limit your downside by having a stop-loss limit. How close you place your stop-loss limit to the index and trend lines may prompt you to bail out too early. You need to balance an acceptable loss to your investment and not react to short-term volatility as the trend changes.

Limiting the downside on false flags

As we touched on above, it is important to have stop-loss limits to limit your losses when false flags occur. It was surprisingly difficult to find examples of false Golden Cross flags for E-Mini S&P 500 Futures. Therefore, we have narrowed the moving averages from the 50- and 200-day figures to the 20- and 50-day moving averages. This injects a greater degree of volatility, giving us a few examples of false Golden Flags.

In the shaded area below, you can see that the blue 20-day moving average moves up through the red 50-day moving average towards the start of June 2016. There was a relatively short period of consolidation and then the traditional climb higher, as buyers took control. In this example, the new trend was short-lived and interrupted by a short sharp move down. The index (but not the short-term trend line) crashed through the 20-day and the 50-day moving averages.

In hindsight, this proved to be a relatively short-term downturn with a quick reversal. The short-term 20-day moving average was unable to pull away from the 50-day moving average. We can also see how the two lines converged in early July. On this occasion, the uptrend was eventually confirmed but not before a period of trepidation and uncertainty. It is worth noting that when the uptrend was eventually confirmed, there was a stronger upward correlation between the two moving average trend lines. 

When the short-term moving average threatened to break back down through the longer-term moving average, the 50-day moving average was relatively steady during the period of concern. Only when the two trend lines began to move in the same direction did the index rally begin to gather real momentum.

False Golden Flag (20- and 50-day moving averages)

False Golden Flag
Source: Finamark

The traditional Death Cross flag is also fairly reliable when using longer-term moving averages, so we have added a degree of volatility to highlight a false Death Cross flag. Using the 50-day and 100-day moving averages, you can see that the 50-day moving average briefly dipped under the 100-day trend line in November. However, there is a fairly quick recovery in the index, which continues the long-term uptrend/new trend, depending on your perspective.

This chart also shows a particular aspect of technical trading that can reduce the Death Cross flag’s effectiveness. You will see that just before the false flag, there was a consolidation/sideways trading period. Consequently, a relatively sharp fluctuation in the index would have a greater chance of creating a false flag. In reality, very few technical traders would commit to a new position until the emerging Death Cross had been confirmed. The dip was relatively short-lived, as you can see from the shaded area. It was also nowhere near as definitive a signal as the majority of investors might require.

False Death Flag (50- and 100-day moving averages)

False Death Flag
Source: Finamark

Interestingly, we were forced to inject a greater degree of volatility to find false Golden Cross and false Death Cross flags for the E-Mini S&P 500 Futures chart. This chart perfectly illustrates the additional momentum behind a changing trend. It shows us how the two moving average lines move in tandem.

Final Thoughts

There are a number of factors to take into consideration with regards to the Golden Cross and Death Cross technical indicators:

  • Many investors tend to err on the side of optimism in the medium- to long-term, which can create a greater focus on the Golden Cross.
  • It is important to find a balance between waiting for a changing trend to be confirmed and missing out on the initial leg of a new trend.
  • Since these technical indicators are based upon moving averages, by definition, there will be a lag between day-to-day index movements and the emergence of strong indicators.
  • While potent indicators, Golden Crosses, and Death Crosses should be considered in conjunction with other reliable technical indicators.
  • Successful investors will also incorporate a stop-loss strategy into all of their investment decisions. Reducing your downside while maximizing your upside is the key to successful long-term trading.

Golden Crosses and Death Crosses don’t occur as often as many other technical indicators. Even so, they can be compelling when they do emerge. Many would argue that Golden Crosses are more lucrative due to investors being more prone to bullish long-term sentiment. The beauty of such indicators is the fact there will always be scope for discretion amongst investors. Some may be willing to take excessive risks at the early signs of a change in trend. Meanwhile, others may prefer more solid confirmation, which could reduce their potential profit.

Whatever you believe about these two technical indicators, the proof is in the pudding. The above charts show some powerful signals in years gone by.

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