Blinded By The "Golden Cross"- How to trade using the "Golden Cross"
Brett is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
We are hearing lots of talk lately about the "Golden Cross" and how it's time to buy stocks. In this report we will define what the "Golden Cross" is and what it really mean for stocks.
The Golden Cross Defined.
The "Golden Cross" is a technical term used when the 50 day moving average crossing back above the 200 day moving average level. This signifies a trend that is going from a downtrend over the intermediate term to an uptrend and it is supposed to signify a longer term bullishness. On average it has led to higher stock prices over the next 6 months 81% of the time going back to 1962. We want to stress that it is very important to really understand trading and market behavior before one simply jumps in and blindly buys up the market on these types of signals.
Granted the 50 and 200 day moving average levels are 2 of the most widely watched trend indicators around and seeing both of them in an uptrend signifies exactly that! It signifies we "ARE CURRENTLY" in an uptrend but there is a problem with using this type of movement as a timing indicator.
By the very nature of a moving average they are "Lagging Indicators" and definitely not leading indicators. A moving average price line is made up of the average prices over the past 50 or 200 days depending on what you are looking at. These moving averages can be used in many important ways but buying on moving average crossovers is not one of them. A trader or investor would be better off using the slope of a moving average or a moving average crossover as a trend confirmation rather than as an entry point.
If one gets their trend confirmation from something such as the slope of a moving average (we like the 50 day ma), then one next needs to time their entry based on this trend confirmation and not simply when the crossover occurs. Prior to buying a stock or any other asset class for that matter, one needs to first take a look at where we are, and where we have recently been. When one is able to pause and ask themselves this question, they will save themselves a lot of second guessing and a lot of money.
Before buying on a "Golden Cross" signal
Whenever we look to buy or sell any stock we always look at #1 trend and #2 what has that stock or index done lately. We look at where a stock or index is relative to all other important indicators. In the case of the S&P 500, after last summer’s nasty selloff, we went into a trading range before shaking out the remaining weak hands on October 4 and 5. This was in our opinion a much better indicator of the beginning of an uptrend then the current “Golden Cross” On those days we broke hard through support hitting new lows only to reverse intraday on a strong rally to the highs of the day. This was also accompanied by heavy volume. This type of action occurs much more frequently than a “Golden Cross” signal and this type of action normally means big gains over the shorter term and not over a 6 month period. We pointed out this buying opportunity to readers back in October and the market rallied over 14% in the next 3 weeks.
There were some other higher risk buying opportunities along the way but another strong buy signal was given by the market on December 20 for a December 21 entry. This led to another 7% rally in the S&P 500 only this time the rally sent many of the stronger stocks much higher than that. When you can pinpoint these types bottoms and tops on the S&P 500 just picture what that does to a strong trending stock that has a beta of 2 or more.
This brings us to the recent action and whether the timing of this “Golden Cross” is a time to buy or not. First off where are we now and where have we come from?
Where we have been.
We had 25 trading days since the December bottom and out of those 25, 20 of those days were up days. The days that were down days barely budged to the downside and didn't even break the 10 period moving average shorter term uptrend line. Yes this is very bullish and we have waiting months to get a confirmed trend like this but one must be very careful of a market that has runs 20 out of 25 days. We have gotten too stretched over the short term so it’s time for the market to reset itself.
Where we are now.
We ran straight up with very minimal pullbacks into the longer term downtrend line going back to 2007. The combination of a stretched market to the upside and being at longer term resistance tells us that odds favor a pullback first.
What to do now.
We now have given a bigger picture of what traders and investors should be looking at before pulling the trigger. In order to properly time your entries and exits one must first look to see if we have a defined trend. One must also make sure to look at how stretched over the short term the market has gotten and see if there is any overhead resistance or support near by.
The answer is yes we are in a bullish uptrend but that originally started in October and not simply because the "Golden Cross" is signaling. The "Golden Cross" is a side effect of a strong market and a strong trend but not the cause of it.
We also see that odds favor continued strength in the markets over the intermediate term. The problem is what we also see is that over the short term the S&P 500 could easily pullback to the 1250 mark which would be close to a 5% pullback. There is no reason to sit through a 5% drawdown in your account (or worse in your stocks). The good news is if we do get a healthy pullback to this level this would allow the market to digest the recent gains in a productive manner and get enough strength to continue the rally that started back in October and December.
So to conclude, don’t get blinded by a “Golden Cross”. Understand that it is a sign of a recently strong market rally that may continue in the near future but not a signal to jump in. Why not use the area of the “Golden Cross” as the reference point to trade off of since it is right at support. Any pullback in that area that holds will most likely setup a powerful short term buy entry which should push back up into the long term downtrend line near 1330 once more.
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About The Author:
Brett Marsh is Chief Market Technician of www.GlobalChartAnalysis.com where he provides market commentary and daily chart analysis. He is also chief editor of the “Better Stock Entries” stock service which provides traders with explosive stock ideas for the short term.
Brett graduated from the University of Southern California with a degree in economics. He started his trading career over 17 years ago as a Financial Consultant for UBS before given the opportunity to become a NASDAQ market maker. He then helped start and run several trade desks, making markets in 100?s of stocks. Brett was then given the opportunity to work with Larry Connors and later William O’Neil, 2 best selling investing authors and market wizards. This allowed Brett to learn both Quant modeling and other technical/fundamentally based trading methodologies used by some of the top portfolio managers in the world. Using this unique market insight, Brett has educated and trained thousands of individuals and portfolio managers. He has helped them improve their trading results by using high probability trading techniques which focus on short term, aggressive moves and proper trade management.
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