Human psychology functions in such a way that is predictably irrational as it has been built to react to various conditions in its environment and this plays a critical role in financial market sentiments. Typically, many people react based on various market conditions and this contributes majorly to either a bearish or bullish market. A bullish trend is fueled by greed while a bearish trend is fueled by fear. An example of this market behavior is the effect of FOMO (Fear of Missing Out) – a situation where investors make irrational decisions to buy or dump an asset without conducting any due diligence, usually owing to huge price movements in either direction.
When deciding whether to buy in or sell out in the crypto market, most investors evaluate certain data points which suggest the action they should take. These fundamental analysis usually range from on-chain and off-chain data charts, crypto market experts’ analysis, reputable crypto news channels and more. However, having to study all metrics and indexes available in the market can be time consuming, and investors utilize specialized aggregated metrices referred to as “indicators”. Indicators combine two or more metrices to provide relevant investment decisions, and the the 'Crypto Fear and Greed Index' is one of such. The Crypto Fear and Greed Index provides market participants a glimpse of the crypto market stance by combining market sentiments and fundamental metrics.
In this article, we will further look into what the crypto fear and greed Index does and how it influences investors' decisions.
The Fear and Greed Index in Crypto; What is it all about?
The Crypto Fear and Greed Index is a measurement of the cryptocurrency market sentiment and fundamental metrics. This is one of many indicators that help crypto traders and investors make key decisions to either buy, sell or “hodl” an asset. As mentioned above, fear drives down prices, while greed tends to drive the market trend upward.The Fear and Greed Index was originally founded by CNNMoney to measure daily, weekly, monthly, and yearly investors sentiment in the stock market.
So, whenever the Fear and Greed indicator reaches an extreme (0 or 100), market participants can expect the crypto market to reverse its direction to either an uptrend or downtrend But if the market index reaches a rate of 50, it shows that the market’s state is considered to be neutral.
How to calculate the Crypto Fear and Greed Index
Understanding the psychology of the market helps investors determine whether the market is in a sustainable move or if things have been “overdone.” Considering the crypto markets, this is very useful as the momentum can be so strong.
The Crypto Fear and Greed Index is not complicated to understand. it is quite straightforward. It consists of a numerical value between 0 and 100, zerobeing most fearful end of the spectrum showing that more investors are selling with sharp decline expected to follow.On the other hand, 100 is considered to be the most greedy as it indicates that people are buying.
Whenever investors are becoming too greedy, it indicates that the market is due for a correction. 50 is considered to be neutral or balanced, but if the market is below 50, it means that the market might be undervalued and may be moving for an upswing. If the index sitsabove 50, it means the market is experiencing greed, and may be overvalued and ready for a pullback.
There are various platforms to find the Crypto Fear and Greed Index but the most intuitive ones that follow crypto markets can be found here. Summarily, the index's scale is divided into the following categories:
- 0-24: Extreme fear (orange)
- 25-49: Fear (amber/yellow)
- 50-74: Greed (light green)
- 75-100: Extreme greed (green)
The following information is used to come up with the calculation of the Crypto Fear and Greed Index:
25% Volatility
To calculate the volatility input for the index, the current price of Bitcoin is compared with the average price of bitcoin from the last 30 to 90 days. Volatility sometimes can signify uncertainty and extreme fear in the market. At the time of this writing, the index only uses the pice of Bitcoin and related information. However, there are plans to include a few other major cryptocurrencies.
25% Market Momentum/Volume
This is calculated based on the trading volume and momentum of Bitcoin by comparing the last 30 and 90-day average values. Periods when the market experiences a high wave of trading volume are considered to be a greedy market.
15% Social Media
In crypto market trades, social media plays a huge factor. The index combines both the number of Twitter feeds, tweets that are tagged under related hashtags to Bitcoin and the rate at which users tweet that hashtag. If the crypto communities on Twitter are quieter than usual and are not tweeting, this produces low engagement rates, and may cause the market to enter a fearful state. But a consistent rise in interaction is a good sign of an “overbought” therefore, a greedy market.
10% Google Trends Data
Google Trends data which analyzes keywords related to Bitcoin also plays a huge role. If the number of Bitcoin related words are on the increase, this may mean thatt investors are showing an increased interest in the cryptocurrency market while a decrease also has its impact on the fear and greed index.
15% Surveys
The Crypto Fear and Greed Index also takes into consideration the results of various surveys. It adds up various data sources from public polling platforms to give an idea on how traders feel about the crypto market at any given point in time.
10% Dominance
Bitcoin dominance makes up for 10% of the index as it represents Bitcoin's dominance against other altcoins in crypto market. Although, this could be controversial because the increase of the altcoin market cap could also be as a result of real interest from investors.
Pros of The Crypto Fear and Greed Index
- It is very simple to use as traders are at liberty to divide up the index readings into quadrants, meaning they can come up with specific strategies for each quarter of the index.
- The Crypto Fear and Greed Index is relatively common for traders to follow it.
- It can be used to confirm a reversal signal when used in conjunction with other forms of technical analysis. Also, it can give traders a heads up as to when to take profits in a trade that has already been profitable.
Cons of The Crypto Fear and Greed Index
- It is just a general gauge as to how traders feel so its predictions may not be accurate.
- It is not necessarily standardized as there are other versions with different calculations to its Fear and Greed Index.
- Taking an investment decision based on the Fear and Greed Index sometimes is very risky since the market cannot be adequately predicted. The Fear and Greed Index is a technical indicator, so investors should not make their investment decision solely on its final calculation.
How traders can utilize the Fear and Greed Index
There are various ways to use this index, but the most common way is to allocate your trading capital depending on how the market trend is and the amount of funds that may be entering the market. For instance, if Bitcoin is in a downtrend and the Crypto Fear and Greed Index is shown to be extremely low. At this point, as an investor, you may have to consider to buying more Bitcoin, with the understanding that the index itself does not provide a 100% guarantee.
Beyond buying crypto, the Fear and Greed Index sometimes helps investors to note when it is ideal to take profits on an already existing profitable trade. In the end, all that matters is for you as an investor not to put all your hopes on this Index and combine with other technical and fundamental analysis tools.
Concluding Thoughts
The Fear and Greed Index should always be thought of as a reference to other existing technical and fundamental analysis, and no trade should be carried out based on the index alone as they cannot always predict the future accurately. If you want to be successful as an investor or trader, it is advised to compare numerous indicators in combination with knowledge gained in the domain of technical analysis.
Also note that the crypto market is highly volatile and the Crypto Greed and Fear Index can generally be used to assess short-term and medium-term price predictions. It is not suitable for long-term price prediction because the indicator is prone to rapid changes and can be easily affected by new factors.
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