- March 11, 2020
- Posted by: CoachShane
- Categories: Trading Article, Trading Indicators
The Golden Cross is a combinations of moving averages that shows when a market turns from a downtrend into an uptrend.
It does not happen too frequently as there have only been 16 S&P 500 golden crosses in the history of the index prior to the one in 2016.
When it does occur, financial media outlets stress how important it is to the market while investment firms take note of it.
What Is A Golden Cross In Technical Analysis?
A golden cross is made up of two simple moving averages,
- 50 period SMA and the 200 period SMA,
- A golden cross is when the faster 50 SMA, crosses over to the upside of the slower 200 SMA
- The death cross is when the 50 SMA crosses below the 200 SMA
- The 200 DMA is important because it has been said that many institutions look at it for bullish and bearish conditions
The time frame used is the daily time frame so it is not something a scalper would consider.
A Golden Cross means that the instrument that it occurs on is now in bullish mode and most traders will look for long trading positions in those markets.
On the left side of this daily Forex chart, the market would be considered a downtrend as the 50 SMA is trading below the 200 SMA.
The yellow circle highlights where the 50-day moving average crosses above the 200-day moving average.
The golden cross definition can be: When the short term moving average, the 50 period SMA crosses the longer-term 200 period SMA to the upside, the golden cross has occurred and we can consider a bull market.
Simple Moving Average Formula
Traders should understand that there is no magic in moving averages. They are mathematical calculations and the simple moving average is the easiest one to calculate.
Using a 3-day moving average as an example, we take the prices of the last 3 days, add them together and divide them by 3:
- This day the price is 1.85
- This day the price is 2.10
- Today the price is 2.76
The calculation for the SMA is 1.85+2.10+2.76/3 = $2.23. On the open of the fourth day, the moving average would be plotting at $2.23.
- The calculation for the 50 periods moving average for the golden cross will take the sum of the closing prices of the past 50 days and divide by 50
- The 200 periods moving average would take the sum of the closing prices of the last 200 days, divided by 200.
The 50 and 200 periods are nothing special except we are looking at a short term trend direction compared to a long term trend direction.
You can use different combinations close to those two numbers and see virtually the same results.
Golden Cross Trading – Does It Work?
Using the golden cross as part of a technical analysis approach may appear to make sense. After all, the talking heads like to refer to it and we are using a well known technical indicator.
- Does the golden cross in trading have any predictive power?
- Do stocks engage in powerful bull trends after the golden cross occurs on the S&P?
- Do all liquid markets react positively to this trading event?
Charles Schwab is a popular financial firm and their chief investment strategist, Liz Sonders, reported to their clients that “Performance following Golden Crosses was no better than the performance over any random time period.”
Any long positions on the daily chart retraced soon after the cross which would have your trade in a drawdown.
Interesting to note that the cousin of the golden cross, the death cross (bear market signal), outperformed the golden cross on this chart.
While traders flock to the golden cross indicator and others to decipher the market, ensure you understand that they may or may not offer you a trading edge.
How To Use A Golden Cross Indicator
A golden cross occurs when the 50-day moving average crosses the long term moving average, the 200 day – so what does that mean?
All we are seeing is a shorter-term calculated average increase faster than the longer-term average. There is no edge in that.
One of the main issues when using moving averages as your buy and sell signals is the problem of whipsaw.
Whipsaw occurs when price action does not have a sustained direction and as it swings back and forth, so will the moving averages as they cross.
So what can we do if we are convinced we need to use this cross in our trading?
Use it for the higher time frame trend determination.
A golden cross is generally talked about in relation to the stock market, so let’s take a look at an individual stock.
Apple stock had a nice 116% increase price since the cross occurred in 2016. If your exit is using the death cross, you lost 35% of your gains and for many traders, that is unacceptable.
We can use the uptrend that is confirmed by the cross, and only take buy orders on the lower time frame. This is multiple time frame trading and in my opinion, one of the better ways to use the cross.
This chart is the four-hour chart of Apple and remember, we are in an uptrend on the daily using the golden cross as our trend confirmation.
We will trade the cross with range trading and standard technical pullback trading strategy.
- The cross occurred on this time frame showing that this smaller time frame trend is heading up. We see momentum move and basing at highs. This is a price action pattern you can trade.
- Standard pullback trade
- Pullback trade with gap
- Basing at highs of momentum – a price action trading pattern
- Two simple pullbacks although many traders may sit out the second one due to lack of follow-through of the first
- While this is a pullback, good pullbacks to trade have a corrective decline that lacks momentum. This does not.
- Gap and thrust down is a pullback you’d ignore if looking long
The black line shows where the daily chart had a death cross. We would stop trading this stock.
Stop Loss and Profit Targets
You need a stop loss to protect the downside and for that, a multiple of the average true range is a good tool to use.
Since the golden cross is a trend following strategy, you may wish to wait until the death cross occurs as your exit. As seen above though, you may give back a large percentage of your gains when doing so.
Still, it is a simple way to manage your trade as you will spend very little time doing so. Many traders could use more time away from their positions in order to not micro-mange them.
We discussed a lot in this article and to sum it up:
- A golden cross bullish signal is when a 50-day moving average crosses to the upside over the 200-day moving average
- Trading moving average crosses can result in a string of losses due to the whipsaw effect of price
- Minimal time is spent managing the trade as your exit is the reverse cross, the death cross
- Using the golden cross as multiple time frame trend tool plus the use of standard price patterns may be a better way to trade with it
Hope you enjoyed this article and remember that being a risk manager is your first priority. Remember that when testing any trading strategy.