October 17th, 2014
by Rick Wright, Online Trading Academy
Hello traders! In honor/anticipation of the upcoming Halloween holiday, this week's newsletter will be devoted to a spooky conventional technical analysis term that I am actually a huge fan of. However, not in the conventional way! Let's talk about the Death Cross!
First of all, a Death Cross is defined as when a security's 50 day moving average crosses below it's 200 day moving average. On the opposite side of the coin, a Golden Cross is when the 50 day moving average crosses above the 200 day. While many trading books and classical technicians believe that a security is bearish when the Death Cross happens, and conversely bullish when the Golden Cross happens, when you study the charts you will realize those definitions get you into trades very, very late to the party!<
In the following chart, the two blue circles indicate where the EURUSD had Death Crosses, and the yellow circle shows a Golden Cross. A very common mistake when examining the efficacy of a moving average crossover technique is to look at the price of THE ACTUAL CROSS, that is the pip where the 50 crosses the 200. This would be incorrect. At the cross in the first blue circle, the pip was approximately 1.4337, but the actual trading price was about 1.3765! The prices are not marked on this chart for clarity, but you can go ahead and check your own prices as you see fit. When making the common mistake mentioned, many traders think the signal would have gotten them into the trade at the 1.4337, when in actuality it would have been nearly 600 pips lower.
On the Golden Cross, the crossover came at about 1.3157, when the price was already at 1.4020! Nearly 900 pips late in that example. So, the main take-away is this: when you hear about a Death or Golden Cross, you will almost always be days and hundreds of pips late to joining that trend! So why care about them?
If you are a long time reader of my Lessons from the Pros articles, you know I love to watch the popular business channels on television. The main reason is for the comedy. Don't you find the commentary hilarious? I know I do. The second reason I watch is to possibly trade in the opposite direction of what they tell most people to go. Whenever one of the TV commentators says something like "This stock/index/currency has a Death/Golden Cross happening today, and technicians believe that this is now bearish/bullish..." I immediately look at the chart to see if I can go the opposite direction.
Please don't think that I take the opposite trade immediately! Very often it may take a few days for the right supply or demand set up to be confirmed. Nor do I stubbornly insist on taking the opposite direction trade! However, knowing that most of the time price action is close to having a correction if not an outright reversal after the Cross happens, I will be open to taking a trade very soon.
My main purpose for the article this week is to get you to question the mainstream business news that is available, and to not blindly do what you are being told. Whenever you hear them say "most technicians believe..." you should be very careful! Some conspiracy theorist types believe this is all by design, to confuse and fool the unwashed masses of home traders out there. All I know for sure is that listening to inexperienced traders will lose you more money than it will make you. How many experienced (profitable!) traders do you know that watch business television for all of their trading ideas? I personally don't know any.
There are numerous other technical analysis techniques that are mentioned on television, anything from moving averages, double tops and bottoms, head and shoulders, cup and handles, etc., etc. Always take the commentary with a huge grain of salt; while not EVERY trading idea should be thrown out, always keep in mind our core strategy of trading on the long side in uptrends, entering in a quality demand zone; and trading from the short side in downtrends and entering in quality supply zones.