Your New Best Friend in Crypto Trading

What a Backtest of Crypto Breadth Indicators Revealed

It’s taken for granted that a crypto rally tees off when Bitcoin starts to rally just like it’s widely believed that cryptocurrencies generally do what Bitcoin does. We find this easy to believe because the Bitcoin gets significantly more press. But the same thing happens in equities. When the S&P 500 goes up, few but savvy market participants care what its constituents are doing. But even worse than the excessive press is a misleading chart of Bitcoin’s market cap versus the combined market cap of all other crypto—the ex-BTC market cap—like the one below. At the start of a rally, Bitcoin’s market cap rises before the ex-BTC market cap. To see why this doesn’t imply that Bitcoin is leading, consider that market cap is price x supply. Since Bitcoin’s price is considerably higher than Altcoins, its market cap moves dramatically for smaller changes in its price. For example, a 10% price increase in Bitcoin priced at 60,000 adds 6,000 to its value, while a 10% increase in an Altcoin priced at 1 adds only 0.10. So Altcoins could be outperforming in percentage terms while Bitcoin’s market cap is ‘leading’.

If Bitcoin doesn’t lead Altcoins, then the idea of a 'Bitcoin factor'—where all coins are exposed to Bitcoin—may be misguided. It could be that a 'Crypto factor' drives the crypto market, similar to risk-on/risk-off sentiment in traditional markets When it is on, crypto starts to rally.

I began to question this belief when I made an index of the top 100 Altcoins (excluding stablecoins and wrapped coins) and indexed it to the same price as Bitcoin on Feb 1, 2015 for comparison. I sanity-checked my calculations by first replicating the CMC 100 index published by CoinMarketCap.com. You can see from the chart that while there is a small replication error (it’s difficult to get the exact same weights as CMC), the methodology I used is correct.

I’ve charted this index along with Bitcoin below. It shows that Altcoins started the first major crypto rally. Investors began to warm up to crypto in 2015—Crypto factor on—and started speculating on Altcoins. As more and more coins were introduced, Bitcoin gained its status as the original and most credible coin. So when newbies thought of buying crypto, they chose Bitcoin, and that explains it’s delayed rally in the first major crypto bull market. In the subsequent rallies, sometimes Bitcoin moved first, sometimes Altcoins did—but more often than not, they moved in sync. This supports the idea of a ‘Crypto factor’ rather than a ‘Bitcoin factor’.

Even if you are skeptical the idea of a crypto factor, during a crypto rally or decline, Bitcoin and Altcoins are highly correlated. This makes breadth indicators suitable for timing the start and end of a rally. Using the percentage of coins above their 50-, 100- and 200-DMAs to measure crypto’s breadth, I backtested different thresholds as entry and exit signals for both long and short positions. I didn’t have to include short positions but I wanted to showcase the quality of the indicator’s signal. If you want to be technical about it, assume this strategy is meant to be replicated via Crypto CFDs. CFDs allow traders to profit from price differences allowing them to take both long and short positions (several brokers offer crypto CFDs). You can also short crypto using futures and options, but the results of this strategy would change due to payoff considerations in these assets. Since my focus is on the quality of the signal, I ignored transaction costs due to the difficulty of estimating them for each coin, however, the number of trades is small enough that transaction costs would not significantly change the results.

Percentage of Coins Above Their 50-, 100-, and 200-DMAs

The indicators are easy enough to understand—they simply count how many coins are above their respective daily moving averages (DMAs). I used the a sample of 8301 coins. The 50-dma one moves the fastest and has the most oscillations. The longer the horizon, the fewer the oscillations, and the slower the indicator in capturing the trend. So the 100-dma one is slower and the 200-dma one is the slowest.

Crypto trading is about sentiment, and proverbially, nothing changes sentiment like price. When coins start to go up, they trigger FOMO and a search for the next big coin—further fueling the rally. The percentage of coins above their 50-dma is therefore perfect to find out just when a critical mass has been reached to safely call the start or end of a rally. It is particularly effective in crypto because of it captures momentum and to sentiment.

I also consider the 100- and 200-dma versions. Breadth indicators are often more insightful when you also look at the corresponding price changes. In a case where a crypto rally starts slow, the percentage of coins above their 100- and 200-dmas would be good timing tools.

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