Disclaimer: This article is not meant as investment advice. Use it to supplement your own thoughts and analysis.
Crypto investors can be emotional. Actually, that’s an understatement. Crypto markets are driven by emotion. I’ve looked pretty deeply at fundamental and technical analysis but when it comes down to it, short-term price movements in an irrational market are driven by sentiment. Whether its FOMO, FUD, or one of the million other acronyms we’ve created to explain trading in these markets, human psychology can be quantified and is very valuable. Taking the opposite side of the trade when investors are fearful or greedy can be a very, if not the most, profitable trading strategy out there right now.
“Be fearful when others are greedy and greedy when others are fearful”
— Warren Buffet
In an effort to understand human psychology and behavior in this market, we are excited to release the first effort at creating a comprehensive Fear/Greed Index rooted in traditional finance.
However, unlike other Fear/Greed indexes that have been calculated, we think that given the nature of these markets we need two types of Fear/Greed indexes: one for longer term trends (i.e. using and updating daily) and one for shorter term trends (i.e. using and updating hourly). We will call the long term Fear/Greed index LF/G and the short term Fear/Greed index SF/G for simplicity in the rest of the article.
There are 6 metrics we use:
All metrics are normalized for their respective time period and then rescaled and given a score between 0 (fearful) to 100 (greedy). The resulting index value is an average of the 6 metrics. Thanks to cryptocompare’s API for providing the resources needed to compile this index.
- Momentum: We create a cap-weighted index consisting of Bitcoin and Ethereum to represent the health of the digital asset market, similarly to the S&P 500 for equities. We decided on these two not only for the fact that consistently represent >50% of the total marketcap, but also because other assets are highly tied to their value. Nearly all assets in the market can be obtained through BTC and ETH pairs. In the LF/G index, this value is created by comparing the current value to a 30-day moving average and in the SF/G index this value is created by comparing the current value to a 24-hour moving average.
- Strength: We look at the top 100 coins by marketcap and see how many just achieved all time highs for a given time period. In the LF/G index, this value is created by comparing the number of coins reaching a high over a 90-day time frame and in the SF/G index, this value is created by comparing the number of coins reaching a high over a 72-hour time frame.
- Breadth: We look at the difference in the volume of the top 100 coins on the rise and the volume of those that are declining. Higher spreads in this value (more volume buying than volume selling) implies greed and lower, potentially negative spreads imply fear. In the LF/G index, this value is created by comparing the difference in volume over a 90-day time frame and in the SF/G index, this value is created by comparing the difference in volume over a 72-hour time frame
- Margin Long/Margin Short: We look at the percentage of margin longs to margin shorts on Bitfinex for Bitcoin and Ethereum. Higher values mean greed, and lower values indicate the market is fearful. In the LF/G index, this value is created by comparing the difference in margin positions over a 90-day time frame and in the SF/G index, this value is created by comparing the difference in margin positions over a 72-hour time frame
- Speculation: We compare the returns of an equal-weighted index of Bitcoin and Ethereum to the returns of an equal-weighted index containing the top 100 coins excluding them. This is to simulate the excess return in the altcoin market. A higher value for altcoin returns minus BTC/ETH returns indicates higher greed and vice-versa. In the LF/G index, this value is created by comparing the difference in spread over a 90-day time frame and in the SF/G index, this value is created by comparing the spread over a 72-hour time frame
- Safe Haven Demand: When investors are scared in crypto, they exit completely. “Tethering up,” or selling crypto to USDT, is a common tactic used by investors to shield themselves from further losses. We look at the difference in volume from people buying tether and the people selling tether to get back into the crypto market. When the sell volume of tether > the buy volume of it (i.e. more people tethering up), the market is getting fearful and vice-versa. In the LF/G index, this value is created by comparing the difference in tether volume over a 90-day time frame and in the SF/G index, this value is created by comparing the spread over a 72-hour time frame
So how would you go about using this?
First off, it’s important to note the limitations of both models. The LF/G index updating daily is not going to be reflecting the dynamic changes that have characterized these markets. On the other hand, the SF/G index can’t reflect any long term trends and will be significantly biased to events of only the past week. We recommend using both the LF/G to find days of high fear or greed and using the SF/G to find hours within those days to even more perfectly time sentiment.
Where can I see these indicators?
The LF/G index is the most recent addition to our daily newsletter, CryptoAM. Subscribe to it and get snapshots of the biggest, most influential news in crypto. Who knows, it might even make you laugh.
We are working on getting the SF/G index hosted somewhere. I’ll update this post when that happens.