3 Simple Ways to Trade the Golden Cross
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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 in Trading?
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 cross. The cross requires these two periods as these are the industry standard for the setup.
The setup can be found on any timeframe. However, traders will pay the most attention when the cross occurs on a daily chart. It is called a golden cross because the 50 crosses above the 200-period moving average. This is a major bull sign that the trend has shifted to the upside.
In order to fully understand a golden cross, let's discuss moving averages, which are required to create the signal.
Moving Average Explanation
The moving average consists of a line, which smoothes price action by taking the average closing price over “x” periods. This “x” period is defined by you the trader and really comes down to what suits your needs.
If the moving average is over 5-periods, it will take the closing prices of the previous 5 candles in order to give you an average value for the current period.
Let’s now take a look at a basic example for performing the calculation of a 5-period moving average:
If you have these 5 closing prices of a security, then a simple moving average equals $3.80.
(3.00 + 3.20 + 3.80 + 4.00 + 5.00) / 5 = 3.80
So, on the opening of the 6th candle in this series, the simple moving average would have a value of $3.80.
Golden Cross Signal
Now let’s get back to the golden cross signal. As previously stated, the signal occurs when the 50-period SMA crosses above the 200-period SMA.
The above chart displays a classic golden cross trading example. The blue line on the chart is a 50-period SMA, while 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. Again, this is because the 50-period SMA accounts for a shorter duration than the 200. This is because the blue SMA takes into consideration less periods, making it more sensitive to price moves compared to the 200-period SMA.
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 in the above chart.
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 and are looking to get out breakeven or with a minor gain.
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 we discussed. 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 Trade the Cross for an Edge
Strategy #1 - Look for Setups After a Long Down Trend
All golden cross setups are not made the same. 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 now juice behind the move.
Strategy #2 - VWMA Golden Cross Trading
The VWMA takes into consideration a certain number of periods. However, the indicator places emphasis on the periods with higher trading volumes.
The chart above shows a couple of golden cross indicators based on crossovers of the VWMA. When the blue 50-period VWMA breaks the red 200-period VWMA, we get a bullish signal on the chart.
After this signal, the security enters a long bullish trend. See that the two VWMAs appear to “wiggle” or appear “curlier” than the EMAs and SMAs used in previous examples.
This “wiggle” is caused by higher trading volumes at these points, which makes the VWMA react faster. In this manner, the VWMAs can sometimes create a golden cross signal earlier than the other MAs.
So, all of you traders out there that would like to enter a trade somewhat early, the VWMA could be a method you add to your toolkit to give you a slight edge over other traders.
Strategy #3 - VWMA + SMA Golden Cross Trading
The next trading strategy, in my opinion, is the most reliable of the methods discussed thus far.
Here I suggest you use a simple moving average as your slower moving average and a VWMA as your fast line.
In this manner, we will use a 50-period VWMA and a 200-period SMA. Since the faster MA is a VWMA, it will be even more sensitive due to higher trading volumes. I believe this is a good approach since it is the trigger MA – the one which creates the golden cross.
The blue line on the chart is the 50-period volume weighted moving average. The red line is the 200-period simple moving average.
Notice that we have a third moving average on the chart. This is a 50-period simple moving average.
We have placed this MA on the chart, just so we can see the difference between the VWMA and the SMA signals.
As you see, the blue and the yellow lines differ slightly because the VWMA also reacts to trading volumes.
The entry of the trade comes when the blue 50-period VWMA breaks the red 200-period SMA. This creates a bullish golden cross on the chart.
See that the 50-period SMA (yellow) reacts slower to the price action. In this manner, this indicator would have placed us into the trade later, which would have cost us part of the bullish price move.
The price then enters a deep bullish trend. On the way up, the red and the blue MAs pretty much move together in harmony.
The price then decreases the intensity of its bullish move. Suddenly, the bullish trend is interrupted and the stock breaks through the red 200-period SMA. At the same time, the 50-period VWMA also breaks the 200-period SMA, creating a bearish golden cross. This creates an exit signal from our trade.
Notice how the 50-period SMA takes more time to break the 200-period SMA.
The good thing is that while the VWMA provides an earlier signal, it’s not so early that you may jump the gun before the SMA makes a cross higher. Therefore, this could give you a slight edge over the other traders or are waiting for further confirmation before opening the trade.
Lastly, since the VWMA is based on trading volume, I think it’s safe to say that volume is always a great indicator of where price will ultimately go for the short-term.
The one item we did not cover in this article is when to place a stop loss. Assuming you will not stay in the market 100%, you will need to determine when it’s time to exit the trade.
A simple approach could be to use the most recent swing low as a point to get off the bus if things start to go against you.
- The golden cross formed by two moving averages. When the faster moving average breaks a slower moving average, we get the golden cross signal.
- The most common moving averages for trading the golden cross pattern is by using:
- 50-period MA as a faster-moving average
- 200-period MA as a slower moving average
- There are two types of golden cross indicators based on their potential:
- Bullish Golden Cross – occurs when the faster MA breaks the slower MA upwards. This creates a bullish signal on the chart.
- Bearish Golden Cross (Death Cross) – occurs when the faster MA breaks the slower MA downwards. This creates a bearish signal on the chart.
- Three other averages you can use to spot a Golden Cross:
- 50-period EMA + 200-period EMA: The EMA indicator has the same functions as the SMA, but it places emphasis on the more recent periods.
- Combine the 50-period VWMA and 200-period VWMA: The VWMA indicator differs by placing emphasis on periods with higher trading volume.
- 50-period VWMA + 200-period SMA: The VWMA will react better to important price impulses, while the SMA will give you a peak into what the “herd” is up to. This method will provide you a slightly earlier trade signal versus using two SMAs.
If you want to take a deeper dive into the historical significance of the golden cross and the broad market, check out this article from the big picture. The data goes all the way back to 1930!