Follow These Technical “Crossovers” to Profits

Technical analysis has become so commonplace that even though fundamental analysts may dismiss it, they still follow the most widely accepted technical analysis measures, because they know everyone else is doing so.

Two such widely used measures that technical analysis has uncovered can help investors maximize their returns and/or reduce their losses.

The simple moving average in technical analysis measures the average price of a particular stock or market over a period of time. A five-day simple moving average is calculated by taking the closing price of a stock or market for five consecutive days, adding them together, and dividing by five, to achieve the average price during that period or, in technical analysis terms, the five-day simple moving average.

The most important and most used simple moving averages are the 50-day and the 200-day moving averages. The 50-day simple moving average in technical analysis captures the medium-term trend of a market or stock. The rule is that, as long as the price of the stock on the technical chart trades above the 50-day moving average, the stock is said to be trending higher or in an uptrend in the medium term.

The long-term uptrend or downtrend can be defined by the 200-day simple moving average. As defined by technical analysis, a stock that trades below the 200-day moving average is said to be in a bear market. Conversely, a stock that trades above the 200-day moving average is said to be in a bull market. For this reason, the 200-day simple moving average is a very important indicator for a market or stock, according to technical analysis.

One of the most watched technical indicators on a technical chart is the crossover. When the 50-day simple moving average crosses above the 200-day moving average on the technical chart, this is bullish for the stock or market being followed. This is known as the “golden cross” in technical analysis because the medium-term indicator has gained more momentum than the longer-term indicator, which means the stock price has momentum behind it to make it rise.

When the 50-day moving average crosses below the 200-day moving average on the technical chart, this is bearish for the stock or market being followed. This is known as the “death cross” in technical analysis, because the medium-term indicator is losing more momentum than the longer-term indicator, which means the stock price is set to fall.

As always with technical analysis, a visual example via a technical chart is the best way to illustrate the theory.

Chart courtesy of www.StockCharts.com

The above is a technical chart of Oracle Corporation (NASDAQ/ORCL) from 2010. Notice point number three, where the 50-day moving average (green line) crosses below the 200-day moving average (red line). Right after this death cross, the stock price of Oracle traded lower.

Now take point number four on the above technical chart. Here the 50-day moving average crosses above the 200-day moving average, which is known as the golden cross, signaling bullish momentum. Notice how the stock of Oracle continued to trade higher after the bullish crossover.

The golden cross and death cross are useful technical indicators that can help an investor know when to buy and/or sell a stock or market. They are common yet powerful tools in technical analysis that investors should be familiar with and use.