Traders usually open the transactions basing on the signals received from the technical analysis tools. Sometimes, a candlestick pattern or one indicator is enough to provide trading signals. Sometimes, traders use a combination of a few. Today’s strategy called a golden cross relies on two moving averages. Is it really such a golden method of trading? Let us take a look at it.
A golden cross definition
A golden cross in the traders’ world is the situation when two moving averages are crossing each other. However, these moving averages have to be very specific. One needs to have the period set for 50 and the other one for 200. Then, the 50-day moving average has to cross higher than the 200-day moving average.
A golden cross occurs when the up movement in a short time happens faster than in a long amount of time. This is a true golden cross that gives a signal to open a buy transaction.
Three phases of the golden cross
During the first phase of the golden cross, the downtrend is coming to an end. We can see that a 50-day moving average is running below the long-term moving average.
The second stage is the recovery of the stock. The 50-day moving average crosses above the 200-day moving average.
The short-term moving average proceeds moving up in the last phase. It can signal that the market is in the uptrend.
The price bars are developing below both moving averages. The SMA50 is initially running below the SMA200. There is definitely a downtrend in the market.
Then, the prices begin to rise and the SMA50, which reacts faster than the long-term moving average, also starts the upward movement.
Finally, the moving averages cross each other. The SMA50 moves over the SMA200. We have a golden cross here.
In the last phase, the SMA50 continues its upward movement.
Trading with the golden cross
You now know what the golden cross is and how to identify it on the price chart. There are, however, a few approaches to trading with the golden cross.
One says, that you should look for a golden cross after a long downtrend. The signal after a very long downward movement is supposed to be pretty powerful.
The next one suggests avoiding spreads between moving averages that are too wide. You must observe not only the moving averages but the price action as well. When such a wide gap occurs is better not to take action after the golden cross is identified.
Another approach recommends using the golden cross in combination with the double bottom pattern. First, you should search for the double bottom pattern on the chart. Then look for the golden cross to occur. And next wait until the price retests the SMA200. Buy after retesting and set a stop loss below the low of the double bottom formation.
Getting out of the trade
You know that you should enter a long trade when the golden cross occurs. But when should you leave the trade?
The answer is not that simple as it all depends on the stock and the settings at the time of the transaction. One way is to define the resistance areas which can be used to identify the right moment to sell.
You can also wait for a death cross which takes place when the short-term moving average crosses back below the 200-day moving average. The drawback here is that the moving averages are lagging indicators so you will lose quite a big part of your profits if you wait with closing the trade until the death cross.
Another option is to draw an uptrend line and use the moment it will be broken as a selling opportunity.
The golden cross can be used as a very powerful trading signal. However, it should always be traded with great consideration. You should not open long transactions every time you note the golden cross. Always analyse the market carefully.
Expert opinions are divided. Some consider the golden cross as a reliable indicator for opening long trades. Others argue that while it is true that big movements often begin with the golden cross not every golden cross result in a big move.
Many financial experts suggest using the gold cross with other indicators in order to get a confirmation for the signal received. It might be the RSI or MACD, for example.
Make use of demo accounts often offered by brokers for free. You can practice trading there any new method you come across.
Wish you highly profitable trades!