A golden cross occurs when a faster moving average crosses above a slower moving average. It sounds simple, but the key is which moving averages to use and in which direction the crossover occurs. Specifically, you need 50 and 200 period simple moving averages (50SMA and 200SMA). Crosses of moving averages with other values will not be considered a golden cross.
As for the direction of the crossover, the 50-period moving average would have been below the 200SMA before the crossover occurred and then crossed upward, as in the example below.
This tells traders and investors that momentum may change when the lines cross. If the rate of upward price movement on a smaller time frame is higher than on a longer time frame, this is considered a sign that it will be possible to enter long.
With higher trading volumes and higher prices, the golden cross may be a sign that the stock market and individual stocks are poised for recovery.
Three stages in the formation of a golden cross
When a downtrend in a market ends, the short-term 50-day moving average falls below the 200-day moving average.
At a crossover, when the asset recovers, the short-term 50 SMA crosses the long-term 200 SMA. Hence the term golden cross, when two lines intersect on a chart.
At the last stage, the short-term moving average 50 SMA continues to move upward. This is usually a sign that the market is in a bullish trend.
Is the golden cross considered a signal to go long?
The golden cross does not guarantee that the trend will become bullish in the future.
SIGNAL
The chart above is a classic example of a golden cross, $TSLA stock. The dark blue line on the chart is the 50 SMA, and the red line is the 200 SMA.
The chart begins with a strong bearish trend, with the price trading below both the 50 and 200 SMA.
Suddenly the direction of the trend changes and the price begins to rise. Naturally, the 50 SMA reacts faster to price changes since it is more sensitive to recent price changes.
Once the 50 SMA crosses above the 200 SMA, we see a golden cross. It is marked with a gray circle.
Death Cross
You can wait for the 50 SMA to cross below the 200 SMA (golden cross in reverse) and use the opportunity to go short. The only problem is that you may miss out on some of your profits because moving averages are a lagging indicator.
An example of a death cross after good growth in Chipotle (CMG) stock.
Please note that the signal to short came after the stock had already rushed down. The profit would still be significant.
Past support
What you can also do is proactively look for areas of resistance that previously held the stock for an extended period of time and will now act as short entry opportunities.
The risk is that the stock could consolidate and go higher.
Breaking the trend line
If the golden cross is confirmed, then you can use the first few retracement lows to create a trend line. Hold the position until the trend line is broken.
Example of a golden cross
If you don't want to wait for the 50 SMA to cross the 200 SMA and form a death cross, you can make money on a trendline breakout.
In this particular example the profit would be 100% in 7 months.
3 Golden Cross Trading Strategies
Strategy No1 - Look for setups after a long downtrend
Not all golden cross setups are created equal. One method you can use is to find an asset that has had a long, sustained downtrend and is now ready to go higher.
The strength of this signal is that the crossover occurs after a multi-month downtrend.
You can enter long when the 50 SMA line is broken, but keep in mind that the price may still roll back down several times before heading higher.
Strategy No2 - Avoid wide distances between moving averages
Sometimes there is a large distance between moving averages. They will form a shape in the form of a cup with a handle. At first glance, this will look truly optimistic.
However, if you look at the price action, you will notice that the pattern is unhealthy. Firstly, the price is rising rapidly. What happens when a stock goes parabolic into a strong major trend? Usually then a reversal occurs.
Don't ignore price action. Parabolic reversals should be viewed with caution. Especially if there is a gap that acts as a resistance level.
These types of gold crosses should probably be avoided due to the high risk.
Strategy No. 3 - double bottom and golden cross
Below is a description of the setup
Find a double bottom on the chart. The second bottom should be lower than the first.
Then wait for the golden cross to form. And then wait for the price to retest the 200 SMA.
Enter long when testing the 200 SMA and with a stop below the low of the double bottom.
Conclusion
The golden cross is a powerful trading signal, but it doesn't mean you should enter a trade every time the 50 SMA crosses the 200 SMA.
You will need to further ensure that you are entering into a trade with a real prospect
