What it is and how it works

The Fear and Greed Index was originally developed by CNNMoney for the stock market. CNN takes a balanced approach by assigning equal weights to the indicators it uses. For example, each indicator is given a 14.2% weight.

The seven indicators used are demand for junk bonds, market momentum, market volatility, put and call options, safe harbor demand, stock price breadth and stock price strength. These indicators measure different elements of how the stock market is behaving at the moment.

To calculate this index, CNN looks at how far each indicator has deviated from its mean compared to how far it regularly deviates. They are then assessed individually on a scale of 0 – 100. The indicators are compiled to create the final index. The higher the score, the greedier inventors are at the moment.

What is the Crypto Fear and Greed Index?

The fear and greed index is used to measure investors’ sentiments towards the markets. This index shows whether the markets are bullish or bearish, and it is constructed based on two opposing emotions, fear and greed.

Investors can be irrational when there are extreme market conditions. For example, investors are fearful when the market is depressed and greedy when the market is bubbly. Understanding investors’ emotions presents an opportunity for investors to profit. As famous investor Warren Buffett says, “Be fearful when others are greedy and greedy when others are fearful.”

How is the Crypto Fear and Greed Index calculated?

Alternative.me adapted CNN’s approach and developed a fear and greed index for Bitcoin. The concepts are fundamentally the same, but the indicators used are different. The reason for using bitcoin is because it currently has the biggest dominance (more than a third of the entire cryptocurrency market cap). As a result, the Bitcoin Fear and Greed Index is the most popular and important one in the space. This index is a potential method of identifying investor behavior towards Bitcoin and can be loosely applied to cryptocurrencies in general.

The index is scored from 0 – 100. 0 indicates extreme fear where investors are too bearish on the prospects of Bitcoin. 100 indicates extreme greed where investors are too bullish. This index can be used as a signal to mark the top and bottom of crypto’s market cycles.

Historical Fear and Greed Index.

The Crypto Fear & Greed Index looks at six indicators. The indicators in this index are created from a mixture of quantitative and qualitative measures.

1. Volatility (25%)

Volatility compares Bitcoin’s current volatility and its maximum withdrawal with its average values ​​of the past 30 and 90 days. When there is a sharp rise in volatility, it can indicate that the market is scared.

2. Market momentum/volume (25%)

Market Momentum combines Bitcoin’s current market volume and market momentum and compares it to the average of the past 30 and 90 days. When upward momentum is strong, it can indicate a bullish market.

3. Social media (15%)

The social media indicator uses sentiment analysis calculated from likes, posts, hashtags from Twitter. If the measured interactions increase sharply over a short period of time, the market may be greedy.

4. Dominance (10%)

Dominance measures how much market cap Bitcoin takes out of the share of the entire cryptocurrency market cap. The greater the Bitcoin dominance, the less speculation there is for altcoins, which may signal bearishness among investors.

5. Trends (10%)

Trends looks at Google search trends for Bitcoin-related terms. It takes into account search volumes and recommendations from popular sites.

6. Surveys (15%) – Currently paused

Weekly surveys are conducted on a voting platform to see what individuals think of the markets.

Each of the indicators above consists of scores of volatility and market momentum, while the rest are qualitative scores. Although the Bitcoin Fear and Greed Index differs from the original Fear & Greed Index, both indices fundamentally measure our emotions towards the markets. Investors can use this index to inform them about how the markets are doing.

How relevant is the fear and greed index?

The crypto market is a field of emotions, mainly fear and greed. Periodic rises in sentiment translate into a manifestation of investor emotions and behavior. Triggers of these emotions can be as big as a national financial report and as trivial as a single social media post. Bonds can be spread across the general market or localized to a few assets in the market.

Investors get greedy when they predict favorable market conditions and fearful when the prevailing conditions are not promising for the crypto market. Fear of missing out (FOMO), depending on the intensity of positive events and speculation around the market, investors flock to the market, buy into promising assets and hold on to them in anticipation of even more gains. In situations like this, the buying power overwhelms the selling.

The reverse is the case when the market seems to be about to make a deep dive. Investors are vulnerable to panic selling or panic buying, influenced by market sentiment.

With the Fear and Greed index, investors get an idea of ​​how other investors feel about the market and make their decisions using the information gleaned from the data. Individual decisions may vary anyway. While certain investors move with the market, others may decide to ‘get greedy when others are afraid’. Nevertheless, the Fear and Greed Index simplifies this process and saves investors the resources needed to do this research on their own.

How reliable is the fear and greed index?

The Fear and Greed index has shown impressive accuracy over the years, that is in terms of its ability to correctly represent investors’ sentiments in numbers and scales. The accuracy of the index in terms of price development largely depends on the reaction of investors to the data provided by the index. Consequently, fear and greed emotions have a strong correlation with price development.

Historical statistics show that Fear and Greed index values ​​fall (fear) when asset values ​​fall and grow when there is an appreciation in asset values. This direct correlation is prone to variations, but it does not necessarily reflect the accuracy of the index itself, as the Fear and Greed index only measures the market sentiments and not how it correlates with the value of crypto-assets. These two phenomena (market sentiments and value of crypto-assets) should be treated as ‘separate’ when measuring the reliability of the Fear and Greed Index.

The application of the fear and greed index in investments

Although investors are generally more interested in bitcoin’s fear and greed index, the chances are high that sentiments differ between assets. Investors using the Fear and Greed index must make a number of considerations including;

Asset of interest

Bitcoin dominates the cryptocurrency space and dictates the movement of other assets to some extent. However, there are frequent cases of assets moving against bitcoin. Depending on the sentiments of the crypto community towards a particular asset, it may continue to rise even when bitcoin and the majority of crypto assets see a drop in value and sentiment.

Unfortunately, the fear and greed index statistics are not available for many assets. When available, it should be considered alongside that of bitcoin and any other asset that affects the project in question. Relying only on fear and greed can lead to making wrong decisions.

Duration of investment

The Fear and Greed index may be more relevant in the short term. Investors trading on a shorter term should consider the periodic variation in general market sentiments before trading their assets or marking a buy.

Short-term changes in values ​​and sentiments may be irrelevant if you intend to hold on to your investments for a long period of time. Long-term investors should prioritize the project’s fundamentals over what the index suggests.

Other prevailing conditions

Market sentiments can be offset by various factors and send values ​​in a different direction. These factors may be outside the considerations of the Fear and Greed Index. Projects with a strong volatility control scheme can mitigate the effect of panic selling and even maintain an uptrend while sentiments are low; an opposite scenario can occur when a project’s tokenomics is not really solid. This should be considered along with the fear and greed index values.

Final Thoughts

The stock and crypto markets are volatile, and no single metric can measure it accurately. An investor should always use a holistic combination of market metrics when making decisions.

Savvy investors harness this swing in sentiment and take advantage of it in a variety of ways that include putting their own emotions under control. Panic buying and panic selling can result in serious losses or missing out on tangible gains.

Relative to any other investment space, emotions run fastest in the crypto space. This accounts for the extreme volatility that the space is known for, it’s hard to control your emotions in an environment like this, but it’s essential to your success as an investor or trader. Instead of falling prey to your own emotions, learn to study the situation and make well-planned decisions using information gathered from your studies and past experiences.

The Fear and Greed index should not be the only indicator used when drawing conclusions about the directions of the markets. John Maynard Keynes, a famous economist, once said, “The stock market can stay irrational longer than you can stay solvent.” Be aware of this quote and stay safe trading the markets!

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Daniel Lew

Daniel is enthusiastic about data and technology and is currently researching blockchains.