Golden cross strategy: how it works and how to backtest it

The rule in plain words

• Buy when the 50-day simple moving average (SMA) crosses above the 200-day SMA.
• Sell when the 50-day SMA crosses back below the 200-day SMA. This reverse signal is called a death cross.
• No stop-loss or target in the basic version. You stay in the trade until the averages cross back.

Why traders use it

The 200-day average shows the long-term trend and the 50-day average shows the medium-term trend. When the faster one moves above the slower one, recent prices are stronger than the long-term average.

It is slow on purpose. It ignores daily noise and aims to catch large, long trends while trading only a few times a year.

Where it goes wrong

• It is late. By the time the averages cross, a good part of the move has usually happened already.
• In sideways markets the averages cross back and forth and produce a string of small losses (whipsaws).
• It trades rarely, so a three-year test on one stock may contain only two or three trades. That is too few to judge a rule.
• A sharp fall can take away a large part of the profit before the death cross gives the exit.

How to read your backtest

• Look at the number of trades first. Fewer than about 20 trades tells you very little.
• Compare the strategy's return with simply buying and holding the same stock over the same period.
• Check the maximum drawdown: the largest fall from a peak. Ask whether you could sit through it.
• Run the same rule on several stocks and periods. A rule that works on only one stock is probably luck.

Common questions