This week the spotlight has moved from the fan favorite S&P 500 to the tech heavy Nasdaq Composite Index. Technical analysis lovers the world over are descending into the chart of the Nasdaq and its accompanying ETF — the PowerShares QQQ Trust, Series 1 (ETF) (QQQ) to gawk at the golden cross that just transpired. It’s an event, or a signal really, that hasn’t occurred since January 2013.
So what is the golden cross? And, more importantly, how do you make money from it? Read on as the mystery will be unfolded.
To understand the golden cross, along with its bearish counterpart, the death cross, you must first understand the purpose of moving averages on a price chart.
While the benefits of these trend-following indicators are myriad, the benefits worthy of today’s commentary are their ability to confirm trend direction and reversals.
Moving averages are designed to smooth out the erratic day-to-day gyrations of stock prices. Since they add up the closing price of a stock over several days (and then divide by that number of days), they calculate the average price of a stock over time. The two time frames in play for the Nasdaq’s golden cross are the 50- and 200-day moving averages.
Think of the 50-day moving average as an indicator of intermediate-term trends, and the 200-day moving average as indicative of the long-term trend.
The two-month recovery in the Nasdaq has finally lifted the 50-day moving average above the 200-day moving average triggering the aforementioned golden cross.
While those who have been paying attention shouldn’t be surprised at the golden cross, it is a good omen (at least in theory), as it confirms the recent recovery seen in tech stocks.
Hit a Double With QQQ Call Spreads
Traders vying for a direct bet on the Nasdaq Composite can use the Nasdaq-100 ETF which mirrors the moves of the Index. If you believe the golden cross continues to fuel the tech rally for the months ahead consider bullish plays on QQQ. This week’s pullback is providing a lower risk entry if nothing else.
Since the bullish implications of the golden cross typically play out over months we’ll use longer-term options in our QQQ ETF trade to give ourselves plenty of time to be right.
Buy the QQQ March $112/$118 call spread for $3 or better. The max risk is limited to the initial $3 debit and will be lost if the QQQ ETF sits below $112 at March expiration.
The max reward is limited to the distance between strikes minus the net debit, or $3, and will be captured if QQQ can rise above $118 by expiration.
By risking $3 to make $3, the call vertical spread offers the ability to double your money should the golden cross prove prescient.
At the time of this writing Tyler Craig had no positions on any of the aforementioned securities.
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