16 May Does the Golden Cross Strategy Really Work?
Does the Golden Cross Strategy Really Work?
May 16th, 2018
Ah, the magical Golden Cross.
I’ve heard it mentioned on Mad Money, CNBC, and by a trader/educator on a podcast yesterday.
Even people who don’t believe in technical analysis (what??) acknowledge the Golden Cross.
It’s that powerful.
If you don’t know, a “pure” Golden Cross is when the 50 period SMA crosses above the 200 period SMA.
When the 50 crosses the 200, that’s golden–and we buy.
I’m not sure of the origin story or why those numbers were chosen (these are excellent round numbers), but everyone knows the Golden Cross and many people swear by it.
But the real question is: Does it work?
If you had to bet $10 right now, what would you pick? Is the Golden Cross golden or a bunch of bunk?
My first thought when considering it is: Yes, it should probably work.
A 50 SMA crossing up over the 200 SMA on a Daily chart is a basic form of trend following. And we know that trend following is the greatest trading strategy of all time.
If the short term momentum becomes greater than the long term momentum, something is definitely happening. I assume some sort of profitability will follow.
But I also tend not to believe anything in the trading world that’s been regurgitated ad nauseam.
And since it’s so popular, there’s little chance it’s still profitable (if it ever was) because we all know that if strategies get too popular they completely stop working.
So I decided to test it out for myself. Here’s what I found.
First, I decided to do my testing on stocks. Why? Because I’ve only heard the Golden Cross mentioned when people are talking about stocks.
Plus, stocks have a long-side bias which seems perfect for the Cross.
Last, the data on stocks goes back farther than any other instrument.
But I didn’t choose just any stock. I chose the stocks in the Dow Jones.
Why? Because these are stocks that have been around and are going to be around for a long, long time.
If it works, then I want to have tested it on something that we can actually trade going forward.
Here’s my conclusion.
The Golden Cross works. Kind of.
I tested every long trade (the Golden Cross is only for going long) on every member of the Dow Jones Index.
I took every trade and did not use a stoploss. I got in when the 50 closed above the 200, and I exited when the 50 closed back down below the 200. That’s it. That’s the whole strategy.
When I did that, I found that 26 of the 30 Dow members would have been profitable.
That’s great! But also meaningless.
It’s meaningless because we now know the Golden Cross produces profit, but does it beat the market? If it doesn’t, then why bother?
So, to compare apples to apples, Let’s just say we only have a $10,000 account.
Using that number, from 2008 to today (May, 2018), buying and holding the Dow Jones Index would have almost exactly doubled our money. A $10,000 account would’ve turned into a $20,000, giving us $10,000 of profit.
That’s the number we have to beat.
We quickly see that using the Golden Cross on the individual members of the Dow, some would have done fantastically.
AAPL, for example, would’ve produced $37,000 worth of profits using the Cross. Outstanding.
But XOM, on the other hand, would have LOST $3,500 since 2008. That’s not good.
So I simply averaged the returns of all 30 Dow components, and that average turned out to be $7,000 worth of profits.
On average, trading the Golden Cross this way on all of the individual members was less profitable than buying and holding the Dow Jones Index.
These numbers do NOT include current open trades. Many Dow stocks would be in super-profitable open trades as I write this.
V, for example, is still in the middle of a 60% gain at this moment. That’s going to be a huge win no matter what the market does in the future.
And, like I said, many of the Dow stocks are in the middle of big winners right now.
So it’s reasonable to conclude that the Golden Cross is as good or better than buy-and-hold.
And that’s without adding any extra rules to the strategy.
What if we used a time exit rather than a cross down below? What if we had a target? What if we used a stop? What if we used a filter?
Any of those additions could possibly push the Golden Cross to new heights.
In summary, I would say the hype around the Golden Cross is legitimate. It’s a form of trend following, and we know trend following works in the long run. This strategy is worth looking into.
But last week, I read that bitcoin is bearish because it’s about ready to form a Death Cross?
Wait, what’s a Death Cross? And is it something to fear?
We’ll talk about that in Thursday’s YouTube video.