What is the Fear and Greed Index?

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What is the Fear and Greed Index?

No crypto investor wants to buy an overvalued coin only to discover that their long position has been Swiss-cheesed even before the move was made. More often than not, the glittering of a ‘coin’ is a question of unstable human emotions instead of adequate research and tenable data. To properly evaluate the worth of a digital currency and correctly predict the market direction, you must understand the crypto fear and greed index.

This guide will shed more light on the definition, application, and various factors affecting the crypto fear and greed index. We have a bonus section for people who want to know the difference between the crypto fear and greed index and the crypto index.

The Origin of the Fear and Greed Index

The direction of the crypto market, whether bullish or bearish, is not just controlled by the supply and demand force but also determined by the crypto fear and greed index. This is a measure of the change in the cryptocurrency market in relation to investors’ sentiments at a particular period. The index ranges from 0 to 100. An index value of 0 signifies extreme fear while 100 signifies extreme greed.

Originally, the fear and greed index was devised by CNNMoney to statistically track the change in investors’ sentiment in the stock market. The CNN-affiliated site uses seven indicators to calculate its index:

  1. Stock price momentum
  2. Stock price breadth
  3. Put and calls options
  4. Junk bond demand
  5. Market volatility
  6. Safe-haven demand

The CNNMoney fear and greed index is, however, limited to stocks. In this article, we will focus on the crypto fear and greed index.

Crypto investors can access the crypto fear and greed index for Bitcoin via the alternative.me website. Unlike the CNNMoney index, the Alternative.me index is calculated using five indicators, which will be explained in more detail in the next part of this guide:

  1. Volatility: how stable is the coin able to be? Mostly ranked by growth and drops.
  2. Market momentum: this changes daily, and you need to keep an eye on it.
  3. Social media trends: social media plays a large part in FOMO, and the crypto market is particularly susceptible to changes due to hype.
  4. Website surveys: a good way to gauge other people’s opinions online, since they are anonymous.
  5. Bitcoin dominance – Bitcoin’s strength plays a strong role in market volatility.
Crypto fear and greed index over time in graph form
Image source: https://alternative.me/crypto/fear-and-greed-index/

The crypto site only tracks the change in the investors’ sentiments towards Bitcoin.  On their site, they promise to provide separate indices for large altcoins soon. Later in this guide, we will shed more light on these five factors.

Is Crypto Index the same as Crypto Fear and Greed Index?

The crypto fear and greed index should not be mistaken for the crypto index. The former measures market change while the latter represents a basket of cryptocurrencies that are selected and valued by market cap. To best understand the difference between the fear and greed index and a crypto index, you must understand the polysemous nature of the word, index.

An index can refer to a value or measure of a thing for example a contrarian index, oral hygiene index, crypto fear and greed index.  When it comes to investments, it can also mean a basket of stocks or cryptocurrencies regulated by an authority in varying percentages these include: the S&P Index 500 index, Vanguard 500 Index, Oracle Top 5 Index, NFT Platform Index.

In case you choose to diversify your cryptocurrency portfolio, you should compare cryptocurrencies listed in the desired crypto Index. Most crypto indices are made up of Bitcoin and other altcoins. Understanding the differences between Bitcoin and Litecoin (an altcoin) is a great way of starting your journey into crypto index investing.

This ad promotes cryptocurrency within the EU (by eToro Europe Ltd. and eToro UK Ltd.) & USA (by eToro USA LLC); which is highly volatile, unregulated in some EU countries and the UK., no EU consumer protection. Investments are subject to market risk, including the loss of principal.
This ad promotes cryptocurrency within the EU (by eToro Europe Ltd. and eToro UK Ltd.) & USA (by eToro USA LLC); which is highly volatile, unregulated in some EU countries and the UK., no EU consumer protection. Investments are subject to market risk, including the loss of principal.

What is the Relevance of the Crypto Fear and Greed Index?

The crypto fear and greed index helps investors estimate the true value of a cryptocurrency. The market is bullish when the index is high and bearish when it is approaching zero, meaning greedy investors can sometimes up the price of Bitcoin while fearful investors can send its price on a downhill curve.

You have to ensure that you do not buy a coin at a high cost just before an inevitable market crash.

Also, you must resist the urge to buy cheap coins that have no future probability of appreciating, like for example NuLINK, NOAHcoin, Nexxo, MurMur, among others.. 2018 saw the rise and death of about 264 cryptocurrencies. These forgotten cryptocurrencies are also called dead coins. These coins cost next to nothing, but there is no probability that their value will ever increase.

Crypto fear and greed index showing current and historical values
Image source: https://alternative.me/crypto/fear-and-greed-index/

It is noteworthy to point out that experts disregard the crypto fear and greed index as a reliable investment research tool and recommend it as a market-timing indicator.

After making a fair amount of research about the cryptocurrency and its crypto liquidity, the fear and greed index can be used to time your entry into a market position. For instance, the cryptocurrency market experienced a market crash, also known as a cryptocurrency bubble, in early 2019 and 2021. The similarity between the two incidents is that the market experienced a boom before the crash. Before Bitcoin tanked 30% ($31,000) in 19, May 2021, it was valued at $64,000 dollars. Assuming trader X has anticipated the crash on April 14 when the price was at $64,000, they could have short the Bitcoin in April. Then, go long when they noticed a market correction on May 23. This market move would have given Trader X twice their original stake and prevented them from the brunt of the cryptocurrency bubble.

Factors Considered when Calculating the Crypto Fear and Greed Index

The crypto fear and greed index is calculated using five factors. These factors are assigned varying percentages depending on their respective degree of relevance (as decided by the regulating body/site). Below are the five factors:

Volatility (25%)

Compared to altcoins, Bitcoin is more stable. However, the price of Bitcoin compared to the dollar can dwindle based on China banning cryptocurrency mining or Elon Musk taking a swing at Bitcoin mining. For this reason, the volatility of Bitcoin must be factored in when calculating the crypto fear and greed index.

The volatility of Bitcoin is measured by comparing the maximum ‘drawdowns’ recorded recently with the respective average values of the past 30 days and 90 days.

Market Volume and Momentum (25%)

The crypto market volume refers to the overall value of the transactions made in the crypto market, while the market momentum shows the direction of the market whether bullish or bearish. The market volume changes daily and you can get the current value on the CoinMarketCap platform. As of the time of writing, the market volume of the crypto market according to CoinMarketCap is $143.70 billion within 24 hours.

Like volatility, the market volume and momentum are dependent on the recent market volume and momentum values compared to the average values observed in the last 30 days and 90 days. Generally speaking, high buying volumes signifies a bullish market.

Social Media (15%)

Social media affects every part of human life and the crypto market is not ‘spared’. A common tweet from an influencer can affect the whole crypto market. It would be insane not to consider social media in the crypto fear and greed index calculation.

By tracking hashtags, polls, online crypto communities, and certain keywords, Alternative.me can confirm the leading emotion behind the market trend. It is assumed that an increasing interaction rate of a specific coin indicates a greedy market behavior. The two platforms observed are Twitter and Reddit.

Surveys (15%)

Survey, a means of publishing everyone’s opinion without mentioning names, is a great way to knowing what a crypto tribe feels or thinks about the market. The reliability of the survey factor depends on its size. And no survey of a handful of investors can truly capture the ever-changing sentiment of the crypto market.

The site conducts periodic polls intending to pinpoint the sentiments of crypto investors. At the time of writing this indicator was placed on hold by the site admin.

Dominance (10%)

The strength of the Bitcoin market can affect the volatility of other digital currencies. Hence, Bitcoin dominance measures the growth of the Bitcoin market compared to the advancement of other altcoins.

The site maintains that an increase in Bitcoin dominance is caused by widespread fear which comes as a result of the predicted or current reduction in the price of altcoins. Conversely, shrinkage in Bitcoin is seen as a greedy behavior that is motivated by the hope of the appreciation of other altcoins. Either way, the site views Bitcoin as the ‘haven of crypto’.

How Accurate is the Crypto Fear and Greed Index?

When used with proper research, the crypto fear and greed index can make your strategy formidable and help you make profitable moves.

Extreme index values can be relied on for market timing, as the crypto market always corrects unsustainable positions that are majorly driven by emotions. If you use automated Bitcoin trading bots, you can also set your market parameters to align with the index value.

How to apply the Crypto Fear and Greed Index

In times when the market trend is determined by fear and greed, contrarian traders/investors are motivated by the notion that the current leading position cannot be sustained for long. The goal here is not to predict the reversal but to benefit from the market correction. Before making such a move, we assume that you have dotted your i’s and crossed your t’s, research-wise, as it is a financial taboo to invest in a business you don’t understand.

When the market is greedy

Fear and greed index showing greedy historical values
Image source: https://alternative.me/crypto/fear-and-greed-index/

The market is greedy when the crypto fear and greed index is 51 and above. The market tends to correct itself after a period of extreme greed; hence this method is most effective when the index is near 80 and above.

Avoid trading in isolation. Compare the current trend with previous patterns on the candlestick chart. Also, compare the highest point to previous zeniths and the lowest point to previous nadirs. If the fear and greed index is approaching 80, be prepared to have a short bias.

Apart from the crypto fear and greed index, there are other factors you should consider before selling your Bitcoin. Ensure you strengthen your resolve by making adequate research.

When the market is fearful

fear and greed index showing fear historical values
Image source: https://alternative.me/crypto/fear-and-greed-index/

On the other hand, the market is fearful when the crypto fear and greed index is below 50. Similarly, the market reversal is likely to occur after a period of extreme fear. If the fear and greed index is approaching 20, be ready to have a long bias.

Conclusion

At the heart of fundamental analysis lies the crypto fear and greed index. It helps you keep an eye on the state of mind of the average investor. That way, you can make the right decisions at the perfect time. Resist the urge to be contrarian at all times, as the masses are not always wrong. Your trading philosophy should always be backed by evidence, not dogma.

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