Bitcoin Fear and Greed Index: Reading market sentiment
Despite the complexity of the crypto market, it is ruled by two emotions hard-wired in the human brain. A popular gauge of the sentiment — the Crypto Fear and Greed Index — is a handy analytical aid. Yet while it summarizes intent and behavior, investors should take the score with a grain of salt. Read on to learn why, and what tools to add to your trading arsenal.
Fear and Greed Index score
According to its developers — alternative.me — the index aims to “save” investors from their “own emotional overreactions.” Like the stock market counterpart created by CNN, it is based on the following assumptions:
- Greed intensifies in a growing market with a rising FOMO (fear of missing out). In these conditions, a correction may be expected.
- Fear reflects prevailing anxiety and becomes more persistent in crisis times. It may also point to buying opportunities when extreme.
Range of crypto fear and greed
The sentiment in the digital assets market fluctuates on a scale from 0 to 100. This spectrum includes:
- Extreme fear: 0–24.
- Fear: 25–45.
- Neutrality: 46–53.
- Greed: 54–74.
- Extreme greed: 75–100.
Impact of extreme fear and greed on investment decisions
When the going gets tough, emotions overtake reason. Investors, however rational they may try to be, are only human. Acting irrationally, they can make choices that backfire and undermine their long-term goals. Here are a few examples.
- In a falling market, loss aversion clouds all else. The pain of losing is generally stronger than the joy of gains — behavioral economists suggest it is twice as impactful. That said, an index heading to 0 is not unequivocally bearish. It reveals buying opportunities: the prices plunge deeper as the tokens are dumped.
- In a rising market, greed comes to the forefront — the closer to 100, the higher the hopes for further gains. Euphoria, FOMO, and herd mentality cause impulsive buying without research. Failing to DYOR is a rookie mistake that is all too common.
Historically, greed and fear have served as indicators of large stock swings. The same holds for crypto.
Bitcoin’s all-time high on November 10, 2022 ($69,044.77) corresponded to 90 index points. As of September 13, 2023, it is at 41 points, while the price ($26,190.09) is over 62% below the peak.
The previous day, the score touched 30 for the first time in nine months. Fears of looming liquidations involving FTX, Mt. Gox, and the US Silk Road intensified the sell-side pressure, although their actual effect could be limited.
Investors’ psychological biases
The crypto market remains relatively volatile, quickly alternating between red and green. The Fear and Greed Index is handy — by monitoring the score, you can spot impending declines to seize opportunities.
Yet this is not a magic number. Experts warn against relying on it alone, partly because of natural human biases.
Loss aversion is part of a long list. Other cognitive traps relevant to crypto include:
- Bandwagon effect — buying the hype and following the crowd instead of conducting independent research. Also known as groupthink, it fuels greed and inflates speculative bubbles.
- Confirmation bias — focusing on information aligned with one’s conclusions, decisions, or beliefs. This form of tunnel vision makes investors blind to red flags due to overwhelming greed.
- Anchoring — subconsciously relying on a specific reference or piece of data. For example, trading history cannot foretell performance, as it does not concern the intrinsic value of any coin. Hence the adage: “past performance does not guarantee future results.”
Components of Crypto Fear and Greed Index
The index is also known as the Bitcoin Fear and Greed Index, as it is heavily skewed toward BTC. Alternative.me uses five factors to generate it, and the following ingredients have uneven influence based on perceived importance.
Volatility (25%)
The more volatile the market, the lower the risk appetite, the stronger the fear, and the lower the index. Volatility and maximum drawdowns are compared to their 30- and 90-day averages.
Market momentum and trading volume (25%)
Growing fear intensifies the selling pressure — daily dips push the volumes up. Conversely, with more positive swings on the charts, buyers take the lead, driven by stronger greed. The index gauges these correlations similarly to volatility — daily volume and momentum are compared to 30- and 90-day averages.
Social media (15%)
The global social media audience exceeds 4.7 billion — nearly 60% of the world’s population. These networks provide insights into investors’ thinking, and the index sifts through hashtags on Twitter (now X) using a dedicated algorithm.
The assessment goes far beyond the number of mentions, considering the frequency of crypto-related posts and interactions. Lower interaction is associated with growing fear, while greedy environments are thought to stimulate it.
In the past, weekly crypto polls on strawpoll.com were also factored in, accounting for another 15%. While still conducted, their inclusion is paused. The developers plan to add Reddit insights as a complementary source — possibly based on a similar algorithm.
Google search trends (10%)
Googling reflects the prevalent sentiment — spikes of Bitcoin-specific searches have accompanied increased volatility. Greedy behavior corresponds to more searches, propping up the score.
The BTC search terms are essential. These are assigned different weight depending on volume and perceived importance. For instance, googling bitcoin crash or bitcoin price manipulation corresponds to fear and pulls the index down.
Consider the term crypto is dead. The all-time high of its Google search volume was recorded on May 8, 2022. That day, the BTC price nosedived below $35K for the first time in almost a year. Meanwhile, the Crypto Fear and Greed Index halved, shrinking from 18 to 9.
Crypto dominance (10%)
Bitcoin’s market share is constantly shifting relative to all other cryptos. Rising dominance theoretically reflects fear, as investors turn to the pioneer as a “safe haven” and hedge against volatility.
In comparison, altcoins become more dominant in a greedy environment: users feel more comfortable with lesser-known tokens promising huge gains. That said, the reliance on Bitcoin dominance appears controversial.
Key concerns
The current market dynamics cast doubt on the validity of the Bitcoin focus. The main argument is the rise of other “safe haven” cryptos, including ether and stablecoins pegged to fiat or commodities. The Crypto Fear and Greed Index has yet to include them.
At just under 49%, the share of the pioneering coin is far from its all-time high. It held at 40% in September 2022 when the market was reeling from corporate implosions — not far from the 43% at the historical price peak.
How to use Crypto Fear and Greed Index
The index alone does not provide a sufficient basis for financial strategies. It does not tell the future or guarantee a chance to enter or exit faster than everyone else.
However, the general sentiment can help you better understand rallies and local lows. The highest accuracy corresponds to news and short-term changes, but prolonged bull runs are a different story.
So, how to use the index?
Consider it a source of daily insights. A falling score may hint at a future uptrend and an opportunity to buy, hold, or sell your tokens to prepare for it.
While the prices rise along with selling opportunities, do not let a soaring index blind you — an extreme score is a likely harbinger of declines.
The sentiment moves in a typical cycle described above — from optimism to euphoria to dismay and back up. That means any sustainable market — bull or bear — includes multiple phases of both emotions.
Not a forecasting tool
Extreme fear may turn into the first signs of greed. It is also possible the prices will keep plunging and remain low for quite a while. Just the same, nobody knows when a greedy market will stop rising. The sentiment may even stray from the BTC price, as shown below.
Overemphasis on Bitcoin
Overdependence on Bitcoin is short-sighted, given the way the market has evolved. The pioneer’s rivals are now prominent. Ether, for example, is the second crypto by market cap, so it appears reasonable to incorporate the ETH/BTC ratio.
Furthermore, the index overlooks stablecoins and the meteoric growth of DeFi. It also neglects the impact of Bitcoin’s deflationary event — halving.
Slashing of the mining fees, which happens roughly every four years, boosts scarcity and inevitably affects the price. Historically, Bitcoin halvings have been regarded as bullish. Yet the anticipation itself may turn them bearish, baking the impact into the market in advance.
Other gauges of market sentiment
To get a broader picture of the market mood, consider adding two other indicators to the mix — the put-call ratio and the funding rate.
Put-call ratio
In the options market, a “put” is a right to sell, and a “call” is a right to buy at a preset price. As the bullish sentiment grows, traders start preferring calls over puts, with the opposite true for a bearish market.
The number of traded puts divided by that of calls yields the put-call ratio, reflecting the perception of recent events. As a starting point, 1 is unrealistic, as calls are typically more popular, so 0.7 is used instead. Rises above it mean puts become more prevalent as the bearish sentiment builds. Meanwhile, drops below 0.7 and close to 0.5 are bullish signals.
Funding rate
The futures market includes a funding payment mechanism to encourage the match between the price of a perpetual contract and that of the underlying index. A positive rate means long position holders pay a fee to their short position counterparts and vice versa.
A positive funding rate indicates higher interest in going long on leverage, which is a bullish clue. A low or negative value reveals crowding of short positions — and, therefore, a bearish phase.
Key takeaways
The effects of human fear and greed are universal, but proper strategizing requires a mix of tools. Although popular, the Crypto Fear and Greed Index is inadequate on its own. This summary of volume, momentum, social signals, and dominance may prove helpful, but only as a complementary source of clues.
Biased toward BTC, the gauge ignores other market leaders. The developers admit that “analyzing the dominance for a coin other than Bitcoin, you could argue the other way round.” Thus, we recommend including additional objective metrics, like the funding rate and the put/call ratio. A balanced combination of technical and fundamental factors is key to prudent market decisions.
