Golden Cross, another technical idea

I have posted yesterday that all of the major markets have crossed below their 200-day Simple Moving Average (SMA). It is generally accepted that when a stock or an index crossed below its 200-day SMA, that stock or index has entered into a bear market. Being a general rule, there are occasions when the stock or index actually rebounded & continued onto its prior trend. We have witnessed this in our FBM-KLCI in August 2007. Then, our market suffered a sharp selloff which begun in w/e 27/7/2007 and in a mere 4 weeks, FBM-KLCI lost about 18% to hit a low of 1141 (in w/e 17/8/2007). The current selloff started only last week & todate, FBM-KLCI has lost about 7%.


Chart: FBM-KLCI's week chart as at May 24, 2010 (Source: Tradesignum)

The other indicator that market strategists like to follow is the golden cross, which is normally defined as the crossover of the faster 50-day SMA & the slower 200-day SMA. If the 50-day SMA cut below the 200-day SMA, the market outlook is deemed bearish and vice versa. We can see an example of a bearish golden cross in our market in March 2008 and a bullish golden cross in May 2009 (see the chart above). Despite the recent sharp selloff, our FBM-KLCI has yet to record a bearish golden cross. If you looked at the table below, you will see that only two major markets have recorded a bearish golden cross- SSEC & HSI.


Table: Main market indices as at May 25, 2010 (Source: Stockcharts for all indices, except FBM-KLCI where I rely on Tradesignum)

No systems or indicators can be the final arbiter of the state of the market. One has to take into account many factors. The golden cross may give a more accurate reading than the crossing of the 200-day SMA but that level of certainty is purchased at a price of ceding more profits or taking on more losses if you have acted earlier. Similarly, a system or indicator that gives earlier reading may not be better because it would be more prone to whipsaws or false readings.

This article is intended to introduce the concept of the golden cross. I seldom looked for golden cross and the crossing of the 200-day SMA in order to call a potential market top or bottom because they are extremely slow systems. By the time you get the reading, the prices would have gone up or down substantially. In fact, some technicians go as far as using the golden cross as a contrarian indicator. I can see their logic but I would prefer not to do so. For a good reading on the generally accepted usage of the golden cross, check out this post.

Finally, I like to say that no technical indicator or system is foolproof. Technical analysis deals with probability. Even when the signals or readings are bearish, the outcome may 'surprise' to the upside. That's a fact of life that all market players have to accept.