Among the various chart patterns used by stock market participants, the golden cross is one of the most popular indicators, having predicted various market uptrends, such as the 2009 recovery after the financial crisis and the post-pandemic upturn.
Here’s everything you need to know about it.
What is a Golden Cross Candlestick Pattern?
A golden cross pattern occurs in the financial markets when a short-term moving average (MA) crosses above a long-term moving average, signalling a potential bullish trend. The most common instance of this is when the 50-day simple moving average (SMA) crosses above the 200-day SMA. Traders and investors interpret this crossover as a sign that market sentiment is shifting from bearish to bullish, often marking the beginning of an upward trend in asset prices.
Formation of Golden Cross Pattern
The golden cross is a three-phase pattern that indicates a shift in the market's momentum. Here’s how it is formed:
- Downtrend and Convergence: The asset price is either in a downtrend or a sideways movement. Here, the short-term moving average, say the 50-day Simple Moving Average (SMA), will be seen below its long-term 200-day moving average. Once the price of the asset stabilises, the two averages slowly converge.
- Crossover: The crossover is the second stage where the 50-day SMA crosses above the 200-day SMA, when the golden cross is formed. It is considered a bullish signal as the recent price movement, by this time, would have become strong enough to change the longer-term bearish trend.
- Uptrend and Divergence: In this final stage, the short-term moving average remains above the long-term moving average. That is an indication that the asset price is gathering momentum. It becomes a signal to the traders that the price will continue its upward movement and hence they will keep open positions for a long time.
Importance of Golden Cross Candlestick Pattern
There are numerous reasons for the golden cross to be considered an important technical indicator.
- Trend Reversal Confirmation: It is considered a reliable indicator of a long-term trend reversal if confirmed by other technical signals. The application of the golden cross is primarily to confirm the end of a downtrend and the start of a new uptrend.
- Market Sentiment Indicator: The golden cross signals a shift in market sentiment. That the 50-day MA has crossed above the 200-day MA means that recent price movement has witnessed a fair bit of buying pressure -- a good sign for buyers' pressure.
- Widely Recognized: The golden cross is one of the most recognized technical indicators. This means that many traders and institutional investors look out for it, thus enhancing its self-fulfilling nature – i.e., the appearance of the golden cross triggers a buying wave increasing the likelihood of its success.
- Easy to Identify: Because it is a moving average-based measure, the golden cross is quite easy to identify. This makes it easy for new and experienced traders to work with.
Golden Cross vs Death Cross Pattern of Candlesticks
In technical analysis, the golden cross is the opposite of the death cross. Here’s how they are different.
Golden cross: The 50-day SMA crossing above the 200-day SMA confirms an upward trend, suggesting a bullish direction.
Death Cross: This occurs when the 50-day SMA crosses below the 200-day SMA, signalling an eventual downtrend with a downward shift in the market.
Interpretation of Golden Cross Pattern
While the golden cross is a strong indicator of a potential bullish movement, it needs to be evaluated in the context in which it appears. This is the way traders typically interpret the golden cross.
- Bullish Signal: Since the golden cross occurs when the shorter 50-day SMA rises above the longer 200-day SMA, it simply means that the short-term price momentum is strong enough to morph into a longer-term uptrend.
- Volume Confirmation: Most traders will instinctively want to look at volumes around the time the golden cross appears to confirm the signal's legitimacy. If both appear together, you can be sure that the uptrend will pan out.
- False signals: A golden cross can and does suffer from false signals if the market is volatile and non-trending. At such times, the crossover appears and then will quickly morph into a death cross, and a clear direction will fail to appear.
To counter this, traders should use a combination of other indicators with the golden cross, such as the Relative Strength Index (RSI) or the Moving Average Convergence Divergence (MACD).