This article covers one of the most important setups with moving averages – the golden cross.
I will provide an overview of the signal and then dive into three trading examples.
What is a Golden Cross?
A golden cross occurs when a faster-moving average crosses a slower moving average. Sounds simple enough right? However, the key point is the moving averages which constitute the cross.
You need the 50-period and 200-period. Anything other than these two periods and it is not a true golden cross.
The setup can be found on any timeframe. However, traders will pay the most attention when the cross occurs on a daily chart. This is a major bullish sign that the trend has shifted to the upside.
Golden Cross Signal
The above chart displays a classic golden cross trading example. The blue line on the chart is a 50-period SMA and the red line is the 200-period SMA.
The chart begins with a strong downtrend, where the price action stays beneath both the 50-period and 200-period SMA.
Suddenly, the direction of the trend changes and price begins making a move to the upside. Naturally, the 50-period SMA reacts faster to the price change as it has a greater sensitivity to the most recent price action.
Once the 50-period SMA crosses the 200-period SMA to the upside, we have a golden cross. We have highlighted this in the pink circle.
Profit Potential of the Golden Cross Pattern
The profit potential will depend on the stock and the setup going into the trade. I hate to be so vague, but that’s the reality of trading.
What you can do is look for areas of resistance overhead which will act as selling opportunities for longs that have been holding the stock for a long period of time.
Another option is to wait for a cross of the 50 back below the 200 as another selling opportunity. The only issue with this approach is you are likely to give back a sizeable portion of your profits since moving averages are a lagging indicator,
If the golden cross is real, the signal will generate a strong buying opportunity. You can then use the first couple of reactionary lows to create an uptrend line. You then hold the stock until this trendline is broken.
Bullish Golden Cross Pattern Example
Again, we have a bullish golden cross stock pattern when the faster SMA on the chart breaks the slower SMA in a bullish direction.
This is the same golden cross trading signal from the previous chart. However, this time we demonstrate the strength of the signal and the potential run a stock can make after a golden cross materializes.
In this particular example for First Energy Corporation, the stock went on a 9.2% run in 6 trading days.
Not a bad one-week return for all my swing traders out there.
3 Ways You Can Trade the Golden Cross with Edge
Strategy #1 – Look for Setups After a Long Down Trend
All golden cross setups are not equal. One method you can use is to wait for a stock that has had a long sustainable downtrend and then look for a stock that is ready to make a move higher.
Reason being there is so much bearishness in the stock, that the signal has tremendous significance.
The power of this signal is that the cross happens after a multi-year downtrend. By having such a long bearish trend, in order to get a bullish cross, there has to be a basing period. This basing period is the battle between the bulls and the bears.
Therefore, once the stock breaks to the upside, you know there is juice behind the move.
You can buy that initial breakout after the base, but realize you could still be in the thick of a bear, so don’t get married to the stock. Look for opportunities as the stock rises to secure your gains.
Strategy #2 – Avoid Wide Spreads Between Moving Averages
At times the averages will have a widespread. This will present a cup and handle like formation of the averages. On the surface, it’s going to look really bullish.
However, if you look at the price action, you will notice the pattern is unhealthy. First, the price is shooting straight up. What happens when a stock goes parabolic into a strong primary trend – it reverses.
What does this chart example teach us?
You cannot ignore price action, especially when you have a large overhead gap acting as resistance.
For these types of golden crosses, you will want to avoid these setups. While these types of charts are still considered valid golden crosses, there are better opportunities in the market.
So, what’s the trade here? Well, there isn’t one.
As traders, we have to remember that sometimes the best action is no action at all.
Strategy #3 – Combine Double Bottom Pattern with Golden Cross
The last strategy we will cover combines the double bottom chart formation with the golden cross.
Here is the setup.
- Look for a double bottom on the chart. The second low should be lower than the first.
- Next wait for the golden cross formation. Lastly, wait for the price to retest the 200 simple moving average.
- You want to buy the test of the 200 moving average with a stop below the low of the double bottom.
The below chart illustrates this formation.
The golden cross is a powerful trade signal, but this does not mean you should go out here buying every cross of the 50-period moving average and the 200.
You will need to bring a higher level of sophistication to the setup, to ensure you are buying into a trade with real opportunity.
How Can Tradingsim Help?
Tradingsim is the best market replay platform on the web. You can cycle thru thousands of charts and replay the data to see which golden cross setup works best for your trading style.