The aftermath of sharp corrections in Bitcoin (BTC) from its all-time high of $ 64,900 has had a negative impact on investor sentiment, at least in the short term. While some analysts believe it may have bottomed out, others are warning of further decline due to the “death cross” pattern that is nearing close at the time of writing.
For new traders, the name Death Cross itself brings with it a lot of negativity and a sense of impending doom. This sentiment can trigger panic sales, especially if the market was already in a bear phase before the pattern was recognized.
However, is a death cross something to fear or is it a crystal ball that gives traders some insight into when a crash is imminent?
Let’s find out with a few examples.
What is a death cross and how accurate is it?
The death cross forms when a moving average of a faster period, usually the 50-day simple moving average, crosses below the longer-term moving average, generally the 200-day SMA.
The crossover is bearish as it shows that the uptrend has reversed direction. Large institutional investors typically do not buy in a falling market until a bottom is confirmed. As a result, buying dries up and investors holding positions rush to exit in panic, exacerbating the decline.
Before looking at some examples of Death Crosses in the crypto markets, let’s take a look at how the pattern affected the S&P 500 index between 1929 and 2019. According to Dorsey, Wright & Associates, LLC, the average drop after the Death Cross is formed is 12.57% and the mean drop is much smaller at 7.75%.
However, looking only after 1950, the average decrease is less than 10.37% and the median is 5.38%.
While these numbers aren’t surprising, especially for crypto traders used to volatility, the declining convergence of these two moving averages shouldn’t be taken lightly.
History shows that the Death Cross has, in some instances, resulted in massive falls in US stock market indices.
After the Death Cross on June 19, 1930, the S&P 500 plunged 78.84% before bottoming out on September 15, 1932. The next terrifying Death Cross came with a 53.44% correction that occurred December 19, 2007 through June 17. 2009.
This shows how the Death Cross was able to predict a sharp correction in selected cases. However, two sharp declines of over 50% in a 90-year history suggest that the pattern is not reliable enough to immediately scare traders.
The recent bitcoin death crosses
Since cryptocurrencies are still an emerging market, the data available is limited. Let’s look at some examples of the Death Cross and how it affected Bitcoin.
The last Death Cross occurred on March 26, 2020 when the BTC / USD pair closed at $ 6,758.18. However, this death cross turned out to be an excellent contrary buy signal, as the couple had already started on Jan.
Previously, the pair had formed a death cross on October 26, 2019 when the price closed at $ 9,259.78. By then, the pair had corrected 33% from the June 26, 2019 high of $ 13,868.44.
After the cross, the pair bottomed at $ 6,430 on December 18, 2019 and suffered another 30% decline. From the high of $ 13,868.44 to the low of $ 6,430, the overall decline was about 53%.
In another scenario, Bitcoin’s roaring bull market peaked at $ 19,891.99 on December 17, 2017, and the Death Cross formed on March 30, 2018 when the pair closed at $ 6,848.01. By then, the pair had corrected over 65% from its all-time high.
After that, the sale continued and the bear market bottom formed at $ 3,128.89 on December 15, 2018. This meant another drop of about 54% from the Death Cross and an overall drop of 84% from the all-time high.
The examples above show how the death cross appears late in the bear market cycle and investors waiting for the pattern to form are returning many gains to the market. At the same time, placing bearish bets can work for short term traders but could prove detrimental for long term investors.
The central theses
The examples show that the Death Cross is a delayed pattern that forms when much of the decline has already occurred. Typically, long-term investors needn’t panic if they spot the death cross on the daily charts, but it is a signal to be more vigilant and potentially prepare your portfolio for positioning on a variety of unexpected outcomes.
Death Crosses can also sometimes be used as a contrary signal. So if they are discovered, traders should look for other clues on the chart to identify a possible bottom.
The views and opinions expressed are those of the author only and do not necessarily reflect the views of Cointelegraph.com. Every step of investing and trading involves risk, so you should do your own research when making a decision.