For many, the "golden cross," which ties two key moving averages together, is as close as they dare to get. Last month, the golden cross fired off a buy signal on the Nasdaq, suggesting it was time to get long and stay long in the stock market.
A golden cross occurs when the 50-day moving average crosses above the 200-day moving average. And while this analysis is typically applied to the Standard & Poor's 500 or, to a lesser degree, the Dow Jones Industrial Average, it is finding a home with other indexes and even other asset classes.
The question now is whether investors will treat it as the golden goose, a legendary creature that laid one golden egg each day and was killed by its impatient owner, who wanted all the gold immediately.
Theoretically, the golden cross tells us that the long-term trend has turned from bear to bull. Because it uses two averages the signal happens much sooner than using the long-term average -- the 200-day -- alone. Indeed, its inverse for signaling the turn from bull to bear, called the black, or death cross, did a good job warning about the impending market decline in December 2007.
With talk from Wall Street to the Fed saying the recession will end within six months, it seems that the golden cross has merit. After all, the stock market is looking many months down the road, so a bullish signal now matches the recession-ending chatter.
But are investors looking for the easy gold now from their golden goose by buying after such a huge advance has already been made? That would put them at risk for a big correction and kill the goose with losses.
Or are they willing to consider that the Nasdaq may need a bit of rest after a 46% gain from March? In other words, are they willing to have the patience the golden goose's owner did not have to take this market one day at a time?
Let's see how the Nasdaq fared using the golden cross and its black counterpart.
As mentioned, the black cross signal was clearly a good one in December 2007. So was the golden cross that fired in May 2003 to kick off a multiyear rally. However, between these two signals, investors suffered a serious false sell signal in the May 2005 Nasdaq (see Chart 1). They suffered another false sell signal in June 2006 so it appears that this system is not very reliable.
But there is one modification we can make -- changing from simple to exponentially smoothed averages. Exponentially smoothed averages assign more weight to newer prices, and less to older prices, and can be found on most free charting services on the Web.This revised golden cross signal fired on the Nasdaq Tuesday. The real question is whether this modification yields any better results -- unfortunately, the answer is no. The same whipsaws that occurred for the simple moving average pair occurred with the exponentially smoothed pair.
Based on this result alone, it seems as if the golden cross is not much of an indicator. Why then do so many people look for it? The answer may be that the Nasdaq is simply the wrong market benchmark to use. When we switch analysis to the S&P 500 we'll find that there have been no golden or black cross failures since 1998 when the market was rocked by the Asian currency crisis.
There has also been no golden cross signal in today's market (see Chart 2).
more at Barron's online
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