Golden Cross: What Is It, And Should Investors Watch It?

Stock prices increasing and decreasing in value Credit: Shutterstock photo

If you have been following the news, you probably have come across two novel terms in the past few weeks: helicopter money and the Golden Cross. Helicopter money, as I have discussed in a previous article, involves the Federal Reserve issuing a large check to the Treasury to pay for new spending and tax rebates.

The Golden Cross, on the other hand, is a technical indicator which occurs when the short term moving average crosses above the long term mark. This charting pattern typically signals stock gains on the horizon. Recently, we’ve seen a number of assets cross this holy grail including gold, oil and the S&P 500.

Plenty of investors see this as a green light to buy into the market while others question its validity. Despite its growing popularity, there is minimal research on its merits as a trading mechanism.

Basic of the Golden Cross

In the trading world, a Golden Cross occurs when the 50 day moving average rises above its 200 day average. This is typically a telltale sign of bullish sentiment for a stock, reinforced by high trading volumes. Technical traders will often buy stocks in the moments following a Golden Cross and sell when the trend reverses into a Death Cross.

For those unaware of a moving average, it is a widely used indicator that helps smooth out prices by filtering out noise created from random price fluctuations. This is generally measured over 3 time periods; 50 days, 100 days and 200 days. A 200 day moving average will have a much greater degree of lag than a 50-day average because it contains prices for the past 200 days.

As a result, the 200-day average is referred to as a long-term indicator while the 50 day measures short-term price movements. It makes sense then that when the 50-day average passes the 200 moving average, it signals a bullish trend. Investors enjoy this because it strips out day to day volatility and provides a fixed trend that can be tracked over a given time frame.

Does it Work?

This year we’ve come by the cross on a few occasions with gold, oil, the S&P 500 and the Dow. For larger and less volatile assets, the Golden Cross doesn’t occur every day. Since 1970, the S&P 500 has produced 23 Golden Cross patterns. What’s more fascinating is since the last cross happened, the stock market is up nearly 75%.

Clearly there is no reason to doubt the merits of the pattern’s bullish message in the short run, but the longer you are willing to wait, the more powerful the message becomes. Research has found in the 30 days following a Golden Cross, average gains were a meager 1.31%. Over a 12-month horizon however, that number skyrockets to over 11%.

Despite some recent volatility, the Nasdaq should produce its own cross in the following weeks, joining the Dow and S&P 500.

Not so Fast

While the S&P somewhat validated its efficacy, the cross has not always held with regard to single equities. Smaller stocks in particular, which are more volatile, did not perform well after passing the cross in late 2015, earlier 2016. In fact, January was one of the worst months for the markets since the Financial Crisis.

Markedly, the touted pattern means very little when market conditions are unstable. As is the case with investing in general, a single tool is not a surefire way of beating the market. Basic investment strategies such as diversification, weighing risk and general due diligence should not be bypassed for anything including the Golden Cross.

Final Take

Given how poor the markets were last year, the frequent appearance of the Golden Cross in 2016 has been a pleasant surprise for investors and traders. However, as we have seen, this shouldn’t be the end all be all when making investment decisions.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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