Technical traders make stock decisions based on looking at market values and data for a given investment as opposed to considering the underlying fundamentals of that investment . One of the key tools of technical trading is the chart. By charting prices, volumes or other data sets, technical traders feel relatively confident that they can predict where the price of the asset being charted will go. One such technical measure is the golden cross.
The Golden Cross
To find a golden cross, technical analysts plot two moving averages of a stock or other asset's price -- a short-term average and a long-term average. If the short-term average is below the long-term average, but at some point, it crosses that graph and becomes higher, that intersection is called a golden cross. Analysts that look for this pattern consider a positive golden cross to be a signal that the stock or other asset's price is headed higher.
A moving average is a measure of a data set over time. For every time period in a data set, a moving average is found by calculating the mean of that day's value and of the values of the days before it. For example, consider an asset whose price went from $1 to $1.10 to $1.20 to $1.30 to $1.40. The day one moving average would be $1, since there is only one data point. On day two, the moving average would be $1.05, which is the mean of $1 and $1.10. Day three's moving average would be $1.10, which is the average of the first three day's prices, and days four and five's moving averages would be $1.15 and $1.20. The longer the time period that you chart a moving average, the smoother it becomes, since each additional data point becomes less meaningful because there are more points before it, much like how you can really taste a teaspoon of salt in a cup of water but can barely taste it in a gallon of water.
What Golden Crosses Mean
Usually calculated by comparing a 50-day to a 200-day moving average, golden crosses are interpreted to mean that a stock is going up. The idea behind a golden cross is that if an investment's performance is continuing to lag, both the 50-day and the 200-day averages should stay about the same distance from each other. If the 50-day average picks up and crosses the longer-term average, it's a sign that the investment's price has started to increase and that there could be further upward momentum.
Golden Cross Analysis Drawbacks
Golden cross analyses have their problems, though. They can be arbitrary, since although charting 50-day and 200-day averages is standard, investors can choose any average they want to get the result they want. In addition, it doesn't always predict an up market. The Dow Jones Industrial Average, for example, frequently goes down after a golden cross. Finally, it can be hard to gauge whether a golden cross means than an investment's price will continue to go up or whether its price will drop as investors take profits, then start to go up again.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.