What does the index of fear and greed of cryptocurrencies say?

The Fear and Greed Index was developed by CNN Business for the stock market. This is an analytical indicator that evaluates market sentiment. Various factors come into play that carry different weights. The result is a number between 0 (fear) and 100 (greed), where 50 is considered neutral.

The cryptocurrency space is dominated by market sentiment. Typically, greed leads to bullish trends, while fear leads to bearish ones. Human psychology is predictably irrational, as many people react the same way in certain situations. Some scientists argue that fear and greed can influence a person's brain, causing them to abandon common sense and self-control and even call for change. That's what sentiment analysis is trying to capture: It takes human psychology into account when analyzing market sentiment.

Inferences can then be drawn and evaluated to predict the course of price action. An example of such behavior is FOMO (fear of missing out), which occurs especially with strong price changes and inclines market participants to rash actions.

Similarly, technical analysis tools such as trading volumes and historical data can be used to predict price movements.

If people behave in the same way under certain conditions, is it possible to profit by simply being counter-intuitive and behaving differently than others? This is where the Cryptocurrency Fear and Greed Index can help.

What is the Fear and Greed Index?

Inspired by the stock market fear and greed index, Alternative.me developed the Cryptocurrency Fear and Greed Index to put general market sentiment into perspective as fear and greed affect investors' willingness to pay. The goal is to help traders analyze the market and make informed decisions.

To obtain a meaningful result, the quality of the data is critical. Thus, even small errors can distort or even invalidate the analysis. As a result, wrong decisions and placements in the market can cost a lot of money.

Uncertainty in the entire cryptocurrency market can be exploited as a potential opportunity. Often the maximum fear in the market means the emergence of a bearish trend that drives prices down. This could be the perfect time to buy the dip, and can therefore be seen as a buying opportunity for crypto investors. Likewise, extreme greed in the market can cause prices to skyrocket, which could be interpreted as the end of the current bull market and a sign that a correction is coming. In this case, it might be a good idea to sell before the market moves south.

The basis for sentiment analysis is the behavior of the largest crypto exchanges on the market. Often, large price changes occur first there, and then other market participants are guided by them. For example, the analysis of order books gives a figure that is difficult to reproduce in an index, but it can greatly affect the behavior of traders.

How does the index of fear and greed in cryptocurrency work?

Theoretically, you can develop your own index of fear and greed. It is a prerequisite that your data be correct and properly used. For example, a realistic assessment of the consequences of certain events requires some basic knowledge of events and market reactions. The weighting of individual factors also plays an important role in your analysis.

Different zones on the index chart and the slider have different meanings.

Here is how the Cryptocurrency Fear and Greed Index is measured:

0 - 24 = Extreme fear
25 - 49 = Fear
50 - 74 = Greed
75 - 100 = extreme greed
On the index chart, fear (score from 0 to 49) symbolizes the undervaluation of a crypto asset. Greed (between 50 and 100) signifies an overvaluation of cryptocurrencies and a potential crypto bubble. Every 24 hours, the index of fear and greed of cryptocurrencies is updated. To determine its value, we collect data from six different sources.

How is the index measured?

The Fear and Greed Index rating for Bitcoin is made up of the following factors.

Volatility (25%)

Strong fluctuations in the price of cryptocurrencies (high volatility) are a sign of a restless market and a decrease in investor risk appetite, while stable price development means more security. The Fear and Greed Index measures current volatility and compares it to averages over the last 30 and 90 days. Unusual and strong volatility directly affects prices, potentially leading to a knock-on effect.

Market momentum and volume (25%)

Market momentum is the cumulative rate of market acceleration used to measure market sentiment. Market momentum can tend up or down, which can be confirmed by changes in trading volume: The larger the market volume, the more traders are participating in the trades. This indicator can be calculated on the current market volume, using the average values ​​for the last 30 or 90 days. The higher the volume of purchases in a positive market, the higher the greed.

Similarly, market volume can be estimated by the put/call ratio. The formula is derived by dividing the total number of puts (short positions) by the total number of calls (long positions). If the resulting value is > 1, then put options prevail, which indicates that the majority of participants evaluate the market in accordance with negative sentiment (i.e., they expect prices to fall).

Social networks (15%)

Social media is a good place to discuss bitcoin and cryptocurrency. On Twitter, a strong community is constantly watching the market and reacting directly to it. The current market sentiment can be determined by assessing the number of tweets containing certain Bitcoin-related hashtags, as well as analyzing the speed and frequency of interaction with such posts in a certain period of time. Increased interest and increased interactions are usually signs of increased greed.

Social media also encourages numerous forms of “pump and dump.” For example, messages on the Internet can contain supposedly valuable information, spurring the purchase of a crypto asset and creating FOMO. Once FOMO spreads, hasty buyers, without doing enough research, jump on the breakwater, raising the value of the asset and over-inflating the market. The manipulators who posted the information can then sell their shares of the asset, significantly reducing its price. The manipulators can then buy the crypto asset again once its price drops, starting the pump and dump cycle again.

Alternative.me aims to use sentiment analysis on Reddit as a source of social media information to complement Twitter. Accordingly, they experiment with an algorithm similar to the existing one.

Polls (15%)

Polls accounted for 15% of the Cryptocurrency Fear and Greed Index but are currently suspended in the calculation of the index.

Surveys allow you to directly find out the mood of cryptocurrency market participants, as well as other interested parties. Several reputable third-party websites are used to conduct weekly surveys with a sample size of 2-000 people. These surveys help gauge the general mood of the market as the selected samples represent groups of crypto traders and investors.

Advertising campaigns often use this method to present their product in the best possible light. Justin Sun, the founder of the TRON cryptocurrency platform, has been criticized for using this method to advertise his platform.

Bitcoin dominance (10%)

In the cryptocurrency market, bitcoin is king. Its dominance is reflected in its share of the total cryptocurrency market capitalization. The high share of bitcoin may indicate market uncertainty as many investors move their investments from risky altcoins to bitcoin. In this case, bitcoin is considered a safe haven, a less risky asset that protects investors from a sharp drop in prices. On the other hand, when the market is greedier, investors turn to risky assets like altcoins in hopes of making huge profits. This capital shift leads to a decrease in the dominance of bitcoin.

However, this factor can be interpreted quite differently, as a high level of investment in bitcoin can also represent a safe market environment.

It should be noted that the Crypto Fear and Greed Index does not take into account other crypto assets. Given the rise of stablecoins, investors may flock to them as a safe haven instead of bitcoin. So while bitcoin’s dominance may be marginal, the market is still showing bearish signs as investors are reluctant to buy riskier crypto assets.

Google Trends data (10%)

Google Trends is a powerful user interest analysis tool that allows you to evaluate Google entries related to certain search queries. For example, as soon as interest in bitcoin increases, search queries and prices increase. Historically, the rise in Google BTC searches has coincided with dramatic price volatility in cryptocurrencies.

Search queries are weighted by both perceived importance and search volume. As such, not all searches are weighted equally: A search for “Bitcoin Manipulation” indicates a greater level of fear and will carry more weight in favor of bearish sentiment. On the other hand, search queries such as “How to buy bitcoin” reflect market demand and interest, contributing to bullish sentiment.

What does extreme fear and greed indicate?

Extreme levels of fear in the index have always preceded bullish price reversals in cryptocurrencies. At this level, the index shows that prices are low and the fear of losing capital leads to panic among some investors who then sell their crypto assets. This, in turn, pushes prices even lower. For experienced traders, this is usually the best time to buy in the market as crypto assets are likely to be undervalued. The index accurately predicts reversals in the price dynamics of cryptocurrencies. His Severe Anxiety score often predicted price reversals in cryptocurrencies.

Likewise, extreme greed, usually driven by FOMO, often means that market prices are in the overbought zone and crypto assets are overvalued. This indicates a growing risk of a bubble bursting with minimal reward for staying in the market. This is often a signal to either cut the market or sell your crypto assets. Typically, extreme greed precedes a bearish trend.

These results seem to confirm that expressed market sentiment is an accurate predictor of the price reversal of cryptocurrencies. Extreme fear in the cryptocurrency markets has historically turned bullish and extreme greed bearish.

Can the Cryptocurrency Fear and Greed Index be used to predict the market?

The Cryptocurrency Fear and Greed Index is a great indicator for predicting when a local low point has formed in crypto prices and when a rally might occur. It is especially useful when there are new and short-term changes in the market. In the right hands, this index is a valuable tool for timing a change in market sentiment and a subsequent reversal in the price of cryptocurrencies.

The Cryptocurrency Fear and Greed Index tends to reverse as it approaches extreme fear territory. This is the moment when fear turns into the first signs of greed (before entering the territory of full-fledged greed).

The Cryptocurrency Fear and Greed Index can be a useful tool for tracking market sentiment turns. Large fluctuations can provide an opportunity to enter or exit the market before the rest of the market reflects the trend.

The index does not work so well for long-term analysis of cryptocurrency market periods. Within a long-term bullish or bearish period, repeated rounds of fear and greed occur. These switches are valuable for swing traders.

There are several factors that the index does not take into account. First, it does not take into account specific sectors that have shown rapid development, such as stablecoins and DeFi. Secondly, the index does not take into account Ether (ETH), the second largest asset in the cryptocurrency. And finally, the index does not take into account the halving of bitcoin, despite the fact that it can have a significant impact on bullish sentiment due to a huge reduction in supply and lower inflation.

Since the aforementioned factors are not used in the calculation of the Crypto Fear and Greed Index - despite their potential impact on market sentiment - other tools should be used to predict the cryptocurrency market in addition to the index.

Сonclusion

While the Fear and Greed Index of cryptocurrencies can be a very important and useful tool for assessing sentiment in the cryptoasset market, it should never stand alone. Using one indicator is not enough to make an informed decision. Various factors play a role in pricing and should always be considered.

For example, the fear and greed index refers only to sentiment analysis, while technical and fundamental analysis work independently of the emotions of market participants. However, do not forget that some new financial or geopolitical events may cross out any analysis.