Technical Analysis: Moving Average Lines (Death Cross and Golden Cross)
Of all the technical analysis tools available to a trader, moving average lines are the simplest. Yet, that simplicity makes them powerful tools; interpreting them and using them to generate buy and sell signals isn't difficult or subject to interpretation.
A moving average line is simply the average closing price of a stock or index over a set period of days (or a set number of bars, for traders using intraday charts). Each new bar leads to a new calculation of a moving average line's value, and as such, moving averages tend to follow -though lag behind - a stock's or index's trend. The advantage to such a lagging indicator is, however, that it "smoothes out" a chart's volatility to indicate the actual trend, absorbing unusually high or unusually low closes over the specified number of bars used in the calculation.
In the example below, we can see how the 20-day moving average line - the average closing price of the past 20 days - follows the lead of the daily closes of Intel (INTC), and smoothes out fairly erratic day-to-day price action to tell a trader which direction the bigger-picture undertow is flowing.
Moving averages can be used in a number of ways, and with a variety of timeframes. Many traders use multiple moving averages, each with a different timeframe, to generate buy and sell signals.
There is no perfect or ideal way to use moving average lines, nor an ideal timeframe used in their calculation. But, for traders using daily charts, the 10-day, 20-day, 50-day, 100-day, and 200-day moving averages tend to be preferred settings.... either each by themselves, or combinations of those lines all applied simultaneously.
Likewise, the use of moving average lines depends on the trader's preferences. Some traders use a stock's or index's cross above or below a moving average line as a buy or sell signal. And, on the chart of Intel above, crosses above or below the 20-day moving average line would have been decent buy or sell signals, albeit not perfect.
Another preferred way to tap into the power of moving averages is interpreting crosses of a faster moving average and a slower moving average as a buy or sell signal. In fact, it's this type of signal that's become such a standard trading tool that traders have developed a nickname for it... a Death Cross, and Golden Cross.
Both the Death Cross and the Golden Cross are crosses of the 50-day moving average line and the 200-day moving average line. A Death Cross is an instance where the 50-day moving average line falls under the 200-day line, suggesting long-term bearishness has developed. A Golden Cross is a case where the 50-day moving average line moves above the 200-day moving average line, implying long-term bullishness is in place.
An example of both appears in the chart below... a Death Cross for the S&P 500 (SPX) (SPY), and then a Golden Cross.
Note that the Golden Cross accurately signaled bullishness was ahead, but the Death Cross didn't technically materialize until the index had already hit bottom and was already recovering. Strangely enough, though traders still tend to watch for these key crossovers of moving average lines as major buy and sell signals, they don't have a great track record as being buy or sell cues.
Broadly speaking, Death Crosses and Golden Crosses tend to be noted for major market indices, but aren't often used as buy or sell cues for stocks (even though they may be better buy and sell signals for stocks).
To that end, a trader would be well served to experiment with different lengths of moving average lines to find which ones work best for that particular style of trading. Traders would also be wise to look for unique ways to interpret them aside from crosses of moving averages or crossovers of two moving average lines. As an example, some moving average lines make reliable technical floors and ceilings.