What Is A Golden Cross In Trading? Does It Work? (Backtest)
Last Updated on March 21, 2023
The Golden Cross in trading is famous and a cited phenomenon in the media. In this article, we look at the performance of the Golden Cross in the S&P 500.
A Golden Cross involves two moving averages – one short and one long. We use the 50 and 200-day moving averages.
A Golden Cross happens when the short moving average crosses above the long moving average. As a trading signal, it works reasonably well. It keeps you invested in bullish markets and keeps you out of trouble when we get a bear market.
Let’s start by explaining in more detail what the Golden Cross in trading is:
What is the Golden Cross in trading?
A Golden Cross involves two moving averages – one short and one long. When the short-term moving average crosses above the long-term moving average, we have a Golden Cross.
We like to use the 50-day and the 200-day averages. Thus, when the 50-day moving average breaks above the 200-day moving average a Golden Cross is formed.
For some reason, this breakout attracts a lot of media attention and a lot of speculation about a potential bull market. Is this for a good reason? You’ll find out after our backtests further below.
Why should the Golden Cross work?
The stock market tends to be in a long-term uptrend due to inflation and productivity gains, and the Golden Cross strategy aims to exploit this upward bias while reducing losses in bear markets.
In fact, the Golden Cross can help you stay out of a significant bear market, and while the strategy is prone to whipsaw signals, the few big winners can make up for it.
So, how do you use the Golden Cross indicator?
Golden Cross and time frame
When backtesting the Golden Cross, which time frame are we looking at? In this article, we use daily bars. But you can, of course, use any time frame you want. There is no right or wrong in trading as long as it works.
Golden Cross trading rules
The trading rules are simple. When the 50-day moving average crosses above the 200-day moving average, it signals a bullish breakout, and you buy.
Conversely, when the 50-day moving average crosses below the 200-day moving average, it signals a bearish breakout, and you sell your position.
Let’s take a look at a trade example:
Golden Cross example
Let’s show you how a Golden Cross looks on a chart:
In this example, the 50-day moving average broke above the 200-day moving average, signaling a bullish breakout. You could have bought the S&P 500 in July 2020 at 2867 and ridden the trend until you sold in March 2022 at 4173, for a nice 32.4% gain. Of course, not all trades turn out this well!
But how does the Golden Cross strategy perform over the long term?
Golden Cross backtest – does it work?
We backtested the strategy on the S&P 500 since 1960. We used the same trading rules as described above.
This is the complete trade list since 1960:
The strategy primarily involves minimal activity, resulting in a small number of trades- only 32. Each trade lasts approximately 350 days, slightly less than 1.5 years.
Let’s look at the equity curve:
You started with 100 000 and ended up with 5.6 million 60 years later. Please remember that this backtest doesn’t include reinvested dividends; thus, the result would have been significantly better with dividends reinvested. However, it serves to measure the result relatively against S&P 500.
Let’s look at the backtest results, trading statistics, and metrics:
- 32 trades since 1960
- CAGR: 6.6% (buy and hold is 6.9%) – not including dividends
- Average gain per trade is 15.4%
- 78% of the trades are winners
- You are invested 69% of the time
- Max drawdown is 33% (buy and hold 56%)
- Risk-adjusted return is 9.5% (6.6% divided by 0.69)
We found that 78% of the trades were winners, with an average trade gain of 15.4% and an annual return of 6.6%.
While this doesn’t beat buy-and-hold’s annual return of 6.9%, we must consider that our strategy was only invested 69% of the time.
Golden Cross’ results are impressive if we factor in the risk-adjusted return at 9.5%, which we calculate by dividing the annual return of 6.6% by the time spent in the market (0.69).
The Golden Cross strategy has substantially lower drawdowns than buy-and-hold, with only a 33% drawdown versus buy-and-hold’s 56%.
Golden Cross video
What is a Golden Cross in trading – conclusions:
So, there you have it, a powerful trading strategy that can help reduce your losses in bear markets and ride the bull markets.
The Golden Cross works well because it lowers the time spent in the market and, thus, drawdowns. The Golden Cross in trading is all about playing defense.
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