Moving Averages In Digital Asset Markets — The Golden Cross And The Death Cross Explained
An important indicator used in analyzing the price of an asset is the moving average. Averages provide traders an idea of which direction an asset’s price is trending, either on the upside (going up) or downside (going down). In terms of value, a moving average trending on the upside is favorable if it increases the price of the asset. That results in massive gains for investors, but it can also have a downside, which results in massive losses (i.e., rekt investors). Moving averages are used mainly for technical analysis in the stock market. In cryptocurrency markets, the use of moving averages can be used to analyze trends for digital assets like Bitcoin and Ethereum.
The moving average (also called Simple Moving Average or SMA) is the movement of an asset’s average closing price taken from a certain period of time. The most common way to measure it is in terms of a set period of points representing a day. Technical analysts often use a 200-day or 50-day moving average. The points are plotted against each other and this helps analysts predict the movement of prices. An important insight this can provide is the level of resistance and support that can be expected.
The SMA can be taken from a time period from a subset of a data series. The data series is the daily closing price of an asset (P) taken over a certain period (t) or number of days. The sum of the prices from the first term 1 to the last term (n) is taken over the total number of days.
SMA = ∑ (P1 + P2 + … + Pn) / t
I took a 50-day MA data series starting from December 6, 2020 until January 25, 2021 (at date of closing price). Each point plotted is the average of the past 50 days in time series (including the closing price of the 50th or last day in the time series January 25). The first point plotted was the time series average of the previous 50 days. The second point removes the earliest date and takes the next 50 days up until the current day and so forth until the last term (n = 50). For the second point in the plot (P2) can be denoted by:
P2 = ∑ [Past 50 days) / n
If we started on December 6 (P1), then we would have to track back to October 17. On December 7 (P2), we move 1 day forward from the earliest day in the previous point to October 18. You then take the average from each day and plot it on a graph. This will show the trend in the direction the asset is moving.
The MA is customizable from any time period that is required. It doesn’t have to start from a certain date, that is arbitrary. By plotting the data points on a graph, analysts get a smoother view of the price trends. If the asset is performing well, the MA would indicate the move toward the upside or what is referred to as the uptrend. As long as the asset is moving in this direction, it indicates higher lows for support levels and ultimately the expectation is for higher highs (i.e., all-time high or ATH). That would mean that the index indicates the asset is not being oversold yet, and is being bought based on the market demand.
A more advanced form of moving average is the exponential moving average (EMA). This uses weights that measure significance based on more recent data in the time series. Thus, it is also called as a weighted moving average. In SMA, there is equal weight placed on the data series at each point. In EMA, there is more weight placed on the recent points in the data series. It responds much quicker than SMA when it comes to price changes. This is due to more recent price changes, which can be more dramatic as is the case in volatile markets like cryptocurrency.
The EMA is calculated just like SMA, but with additional steps. In EMA, a multiplier (m) is used as a weight to provide a smoothing factor with the number of observations (n). It follows the formula:
m = [ 2 / (n + 1)]
If you were doing a 50 day EMA, then you would get the multiplier:
m = [ 2 / (50 + 1) ] = 0.03921568627451
To calculate the EMA:
EMA = [ P * m ] + [ EMA2 * (1 — m) ]
P = Current Day Closing Price
EMA2 = Previous Day EMA
There are traders or analysts who prefer using EMA since it is more timely in relation to the more recent data points rather than using previous data that all have equal weights. The EMA can compensate for lags in data from a time series since it places more weight on the recent price action. This gives signals on when to enter or exit the market much better than SMA.
If we were to compare SMA and EMA, we could see a difference in the plotting on a graph. The SMA steeps further upwards (represented by the dark blue line). On the other hand, the EMA (light blue line) is trending much closer in price points to the actual movement of the daily prices.
The Golden Cross
When looking for a good entry into the market to buy a digital asset, analysts look at both the 50-day and 200-day MA. When plotted against time, when the shorter MA is trending upward compared to the longer MA, it is a sign of a strong run. The signal becomes bullish at the point where the 50-day MA surpasses the 200-day MA. This is called the Golden Cross, and it is an indicator for entry in most cases. This is because it can signal a rally is about to occur, but it can be deceiving if not analyzed properly. This is because there are other factors, like trade volume among others, that need to be looked at to determine if this is going to go parabolic or if it is just a temporary peak that is about to dip.
The Golden Cross is mainly a positive indicator that prices will continue to newer all time highs. That is the expectation based on the price movement, as a shorter-term trend surpasses the long-term trend (i.e. 50-day surpassing 200-day). The signal is an indication that there is a strong buy signal that is bullish in sentiment. This is the point many traders look for when considering an asset.
The Death Cross
The opposite of the Golden Cross is the Death Cross. This occurs at the point where the 200-day MA surpasses the 50-day MA or when the 50-day MA passes below the 200-day MA. This is a bearish sentiment for traders, signaling the downside. Things can dip further once the Death Cross is reached, but this actually happens often even in a bullish cycle. The indication that things are going to overcome the bears is when the 50-day MA returns to the uptrend and begins moving again with greater price volatility from more pumping into an asset.
Despite the occurrence of the Death Cross, it does not mean the prices of a digital asset will continue downward. It can be an indicator of a market correction the preceded it, in which a massive sell-off took place. That was what happened right before the Death Cross was reached in March 2020. This saw the price of BTC go down from a closing high of $10,326.05 (February 12, 2020) until it came crashing to $4,970.79 (March 12, 2020). This led to a decrease in BTC trading volume, so naturally, it can be expected that the sentiment would turn bearish.
Things can also change over time, if not quickly then, gradually. After BTC took a massive dump in March 2020, it slowly began to recover rather than plunge further below $4,000. At that point, there were buyers of the digital asset at a price point that meets the market demand. By May 21, 2020, BTC began its upward trend once again as it was building momentum with buyers going for the dips.
There are other ways to look at a Golden Cross and a Death Cross based on the analytics. When there is a Golden Cross, the signal becomes bullish, and the sentiment is to hold while others buy. This keeps the momentum going, and you are not forced or required to sell anything. When it breaks to the downside, the Death Cross brings bearish sentiments, and the weaker hands (who don’t HODL) wind up selling to cut further losses.
A Death Cross actually appears more like a bargain to buy a digital asset like BTC at a lower price. It does not always mean the end, but rather a new cycle of accumulation. This is when whales begin to buy more of an asset and then consolidate their hold on it. Therefore, a Death Cross is just a market correction that is often due to taking of profits or FUD in the market. Traders can take this as a buy signal opportunity because it is a discount like an asset is on sale.
Analyzing the data using moving averages can help with trading decisions. It is not an absolute indicator though, which is why it is best to look at other indicators besides the moving average to determine the most likely possibility of an asset’s movement. While traditionally it is used for TA in the traditional financial markets, it has found a place among crypto traders and analysts as well.
Disclaimer: This is not financial advice. This is for reference only. Do your own research to verify information.
First published in The Capital (1/26/21)