What is the Fear and Greed Index?
CNNMoney originally created the Fear and Greed Index to analyze market sentiment for stocks. Later, Alternative.me created its own customized version for the crypto market.
The Crypto Fear and Greed Index analyzes a set of different market trends and indicators to determine whether market participants are greedy or fearful. A score of 0 signifies extreme fear while 100 signifies extreme greed. A score of 50 indicates that the market is fairly neutral.
A fearful market may indicate that the cryptocurrency is undervalued. Too much fear in a market can leads to overselling and excessive panic. Fear does not necessarily mean that the market has entered a long-term bearish trend. Instead, you can take it as a short- or medium-term reference to the overall market sentiment.
Greed in the market is the opposite situation. If investors and traders are greedy, there is a possibility of overvaluation and bubble. Imagine a situation where FOMO (fear of missing out) causes investors to pump up the market, causing the price of Bitcoin to overvalue. In other words, increased greed can cause excess demand, artificially increasing the price.
How does the Crypto Fear and Greed Index work?
Alternate.me calculates a new value from 0 to 100 every day. As of July 2021, the Crypto Fear and Greed Index only uses information related to Bitcoin. The reason for this is BTC’s significant correlation with the overall crypto market in terms of price and sentiment. There are future plans to cover other major coins, including Ether (ETH) and BNB.
You can divide the index scale into the following categories:
0-24: Extreme Fear (orange)
25-49: Fear (amber/yellow)
50-74: Greed (light green)
75-100: Extreme Greed (green)
This index calculates value by combining five different weighted market factors. Let’s take a look:
- Volatility (25% of the index). Volatility measures the current value of Bitcoin with averages from the last 30 and 90 days. Here, the index uses volatility as a surrogate for uncertainty in the market.
- Market momentum/volume (25% of the index). Bitcoin’s current trading volume and market momentum are compared to the average values of the previous 30 and 90 days and combined. Constant high-volume buying signals positive or greedy market sentiment.
- Social media (15% of the index). This factor looks at the number of Twitter hashtags related to Bitcoin and specifically the value of their interactions. Generally, a constant and unusually high number of interactions has more to do with market greed than fear.
- Bitcoin dominance (10% of the index). This inputted measures the dominance of BTC in the market. Increased market dominance signals new investments coming into the coin and a possible reallocation of funds from altcoins.
- Google Trends (10% of the index). By looking at Google Trends data for Bitcoin-related searches, the index can provide insights into market sentiment. For example, a rise in “Bitcoin Scam” searches would signal more fear in the market.
- Survey results (15% Index Score). This input has been paused for some time now.
Why is the Crypto Fear and Greed Index useful?
The Crypto Fear and Greed Index can be a useful tool in examining changes in market sentiment. Large swings can provide opportunities to enter or exit before the rest of the market follows the trend. We can see a quick example of this by examining the last three months’ total cryptocurrency market capitalization versus the index number.
Point 1 shows the date April 26, 2021, which is the base of a significant swing in the index value from 73 (greed) to 27 (fear). Point 2 shows the beginning of another slide on May 12, 2021, from 68 (greed) to 26 (fear). We can tell if this data corresponds to the crypto market by comparing these changes against the overall crypto market capitalization.
Point 1 again shows April 26 starting at $1.78 trillion (USD) before climbing to a peak as high as $2.53 trillion on May 12. If you combine this data with what we saw above, there was a large swing in sentiment from greed to fear that coincided with a local bottom in crypto market capitalization. As the market becomes increasingly greedy, the overall market capitalization increases until it reaches its max. At the max, sentiment once again drops dramatically.
With this example, the index has proven to be helpful in finding buying opportunities and predicting selling within the market. Using such indices, you can check whether your emotional reaction is excessive or in line with the market. However, will these indices always be useful in every situation? Most likely not.
Can I use this index for long-term analysis?
This indicator is not effective also for long-term analysis of crypto market cycles. In a bull or bear situation, there are several cycles of fear and greed. These transitions can be utilized by swing traders. However, for investors who want to maintain their holdings, predicting the change from a bull to a bear market from the index alone will be difficult. You need to analyze other aspects of the market to get a long-term perspective.
As always, the advice is that you shouldn’t rely on one indicator or style of analysis alone. Make sure you do your own research before investing money and only invest funds that you can afford to lose.
The Crypto Fear and Greed Index is a simple way to collect and summarize a series of fundamental metrics and market sentiment. Instead of going it alone, you can rely on this indicator to track social media, Google Trends, and other statistics. If you want to include it in your analysis, consider supplementing it with other metrics and indicators to get a more balanced view.
