Trading the cryptocurrency markets can be highly lucrative, although with the potential for great profits also comes the risk of great losses. Cryptocurrency traders need to utilize every tool they can in order to get an edge, and one of those tools is momentum oscillators. This article investigates several types of momentum oscillators that you can use to make better trades on the cryptocurrency market.
Moving Average Convergence Divergence (MACD)
The Moving Average Convergence Divergence (MACD) is designed to show the momentum of a cryptocurrency’s price. In order to understand MACD it is critical to know how it is calculated.
The EMA is similar to a simple moving average (MA), where the price of a cryptocurrency is averaged out across a certain period, except that the EMA puts greater weight on more recent data points.
The result of subtracting the 26 period EMA from the 12 period EMA is called the MACD line. The MACD is positive when the 12 period EMA is greater than the 26 period EMA, which indicates that the price is moving strongly upwards in the short term. When the EMA is negative that means the price is moving strongly downwards in the short term.
A 9 period EMA of the MACD is then calculated, which is called the signal line, and the signal line is plotted on top of the MACD. The result is a chart like the one below:
Chart showing Bitcoin price (above) and MACD (below), with the MACD Line in blue, the Signal Line in orange, and the histogram showing the difference between the two in green and red. Courtesy of Tradingview.com
The interaction between the MACD line and the signal line can be used to determine when it is the right time to buy a cryptocurrency in expectation of a price increase, or to sell a cryptocurrency in expectation of a price decrease. Essentially, when the MACD line crosses above the signal line that is an indicator that the cryptocurrency’s price will go up since the momentum is strongly upwards in the short term, and when the MACD line crosses below the signal line that is an indicator that the cryptocurrency’s price will go down since the momentum is strongly downwards in the short term.
The difference between the MACD line and the signal line is often plotted as a histogram, with positive values in green and negative values in red, showing when it is a proper time to buy and sell.
The magnitude of the difference between the MACD line and the signal line can also be used to determine overbought or oversold conditions. Essentially, when this difference gets far above zero that could indicate the market is becoming overbought, which indicates a crash may be coming. If the difference goes far below zero that could indicate the market is becoming oversold and a rally may be coming.
There are some caveats to the MACD. Most importantly it is a lagging indicator and not a leading indicator. Basically, the MACD shows that the market already has strong momentum in a given direction based on past data, but this is not a guarantee that the momentum will continue in that direction. Some of the time the momentum continues, and some of the time it does not, so traders should be careful to not make decisions based on MACD alone, and should use other trading indicators in combination with MACD to make the best decisions.
Awesome Oscillator (AO)
The Awesome Oscillator (AO) is another spin on momentum oscillators like the MACD. Just like the MACD, the AO is the difference between two moving averages of a cryptocurrency’s price.
The AO first calculates the median price of a cryptocurrency for each period, and then subtracts the 34 period simple moving average of the median prices from the 5 period simple moving average of the median prices. Similar to the MACD, this is a way to calculate the difference between short term momentum and long term momentum.
When the AO rises above zero that means short term momentum is rising faster than long term momentum, which may be a buying opportunity. When AO drops below zero that means short term momentum is falling faster than long term momentum, which may be a selling opportunity.
Bitcoin price (top) AO (bottom) courtesy of TradingView.com
When using the AO, there is something called the twin peaks method that basically uses higher lows and lower highs to determine the sentiment of the market. If there are two peaks below the zero line, the AO stays below the zero line between the peaks, and the 2nd peak has a value that is less negative than the first, then this is considered a bullish twin peaks setup.
On the other hand, if there are two peaks above the zero line, the AO stays above zero between the peaks, and the 2nd peak is lower than the first peak, then this is a bearish twin peaks setup.
The saucer method is another trading technique derived from the AO which looks for more rapid changes in momentum. On the above chart, the AO is plotted in green and red on a histogram, with a green bar indicating that AO has increased and a red bar indicating that AO has decreased.
If the AO is above zero, there are two consecutive red bars, the 2nd red bar is lower than the first, and then a green bar follows, this indicates a bullish saucer setup.
If the AO is below zero, there are two consecutive green bars with the 2nd bar being less negative than the first, and a red bar follows, then it is a bearish saucer setup.
The AO and its associated saucer and twin peak methods can be useful when trading Bitcoin and cryptocurrency, but once again it is a lagging indicator, meaning that the AO shows that momentum is going in a certain direction based on past data. This means there is no guarantee that the momentum will continue in that direction. Therefore, like with the MACD, AO should be used in combination with more trading indicators.
Variable Changing Price Momentum Indicator (VC PMI)
A more complex example of a momentum indicator is the Variable Changing Price Momentum Indicator (VC PMI), and unlike MACD and AO, there is no simple way to calculate VC PMI.
The VC PMI functions on the basic principle that the price reverts to the mean, and uses several complex mathematical algorithms including wave counts, Fibonacci ratios, Gann principles, supply and demand levels, and pivot points. Unfortunately the VC PMI is proprietary, so it is not free to use, nor is there any way to look into the specifics of how it actually works, or even how well it works. That being said, it is important to know that momentum oscillator science extends beyond the relatively simple MACD and AO.
In summary, the MACD and AO are commonly used momentum oscillators which can be beneficial for cryptocurrency trading. Essentially the MACD and AO determine fluctuations in the momentum of a cryptocurrency’s price. The data from the MACD and AO can be used to suggest when to buy a cryptocurrency and when to sell a cryptocurrency to optimize profits. A critical caveat is that both MACD and AO are lagging indicators, since they are based on past momentum which is no guarantee of future momentum, and it is prudent to use additional trading parameters in combinations with the MACD and AO.
Image Courtesy: Pixabay