Trading the Golden Cross/Death Cross
How effective is the strategy?
David Alan Carter
Traders and the financial commentariat frequently refer to "crosses" made when two moving averages intersect on a chart. Most notably, crosses between the 50-day and the 200-day moving averages.
When the 50-day moving average rises above the 200-day moving average, it's called a "golden cross" and is considered a bullish sign. When the 50-day moving average crosses below the 200-day moving average, it's called a "death cross" and considered a bearish sign.
See Figure 3 for an example of the latter (day-of-cross trading).
Traders are known to stalk charts waiting for a cross of these two SMAs, and trade accordingly. But do the results actually support this strategy?
Let's punch some numbers. In Figure 4, we've picked out 10 large-cap stocks and 3 popular ETFs. These are 17-year total returns, unless otherwise noted (the years 2000-2017). In this case, we're comparing buy-and-hold investing vs. a strategy of trading the security based on the position of its 50-day SMA relative to its 200-day SMA (buying when the 50-day is above, and selling when the 50-day is below).
OK, there were a few successes among these examples. But take a look at IBM, the subject of our "death cross" example in Figure 3. Playing this strategy, you not only would have missed a 93.7% gain at the end of 17 years (modest by any measure), but you would have actually lost money.
Well, that was a bust. If our examples are any indication, playing the crosses is pretty much a gamble. No telling whether your stock or fund will come out in the green or the red until a sufficient period of time has passed. And given a sufficient period of time, we're all dead.
At this point, a reminder is in order. Let's highlight it in a sidebar.
Sidebar: Trend indicators are not, in general, return enhancing. They can be, but where they often shine is in their ability to reduce volatility and drawdown. They are primarily protective measures. And in that sense, moving averages may have a role to play. So why this book's focus on enhancing returns? Don't we care about protection? Actually, we care deeply about protection. But we kinda like returns, too. We're driven to have our cake and eat it, too.
The takeaways from this exercise? If I had to hazard a guess, I would say that trading the SMA crosses fails to predictably and consistently beat buy-and-hold because there are a lot of head fakes and false signals in the marketplace, times when a security or fund appears to be moving in one direction only to end up reversing course and moving in the other. This is especially true for individual stocks; they move to the beat of their own drummers in addition to taking marching orders from the overall market.
And speaking of the overall market, the broader the index and the larger the cap rate of stocks that make up that index, the fewer the false signals. Hence, the more consistent outperformance when applying either of these strategies to SPY and QQQ.
In addition, the days of largest gains (and losses) for individual stocks tend to cluster. Miss a few days of above-average gains, and you lose out on the compounding effect (generating earnings from previous earnings) of those gains for years to come. The SMA strategies we've outlined do not appear particularly good at capturing those gains.
Whatever the reasons, if we want to have our cake and eat it, too, we need a different approach.
Excerpted from the new release
Stock Market Cash Trigger
David Alan Carter
Bookmark: 50-day/200-day Moving Average Crossover, Death Cross, Golden Cross, Bullish Sign, Bearish Sign, SMA Trading Strategies, Buy and Hold Investing