Fear and Greed Index Explained
The crypto fear and greed index is an analytical tool created to help investors in making an educated decision when it comes to investing in cryptocurrencies.
The crypto market behavior is extremely emotional. People tend to get greedy when the market is rising which results in FOMO (Fear of missing out). Also, people often sell their coins in irrational reaction of seeing red numbers as prices drop. With our Fear and Greed Index, we try to save you from your own emotional over-reactions. There are two simple assumptions:
- Extreme fear can be a sign that investors are too worried. That could be a buying opportunity.
- Extreme greed usually means the market is due for a correction, as the supply of new buyers get exhausted.
Therefore, we analyze the current sentiment of the Bitcoin market and crunch the numbers into a simple meter from 0 to 100. Zero means “Extreme Fear”, while 100 means “Extreme Greed”. See below for further information on our data sources.
Warren Buffett on Fear and Greed
The market aberrations produced by [fear and greed] will be equally unpredictable, both as to duration and degree. Therefore, we never try to anticipate the arrival or departure of either disease. Our goal is more modest: we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
Buffett returned to this theme periodically in subsequent years. His key insight remained the same, though. There’s no way to know when greed-driven rallies or fear-driven market declines will end. As the old saying goes, “The market can remain irrational longer than you can remain solvent“. In other words, crazy high prices reached during bull market rallies can remain crazy high – and go even higher – longer than you think they will.
The best thing long-term investors can do when the market seems to be caught in a speculative bubble is to act extremely cautiously — which might mean selling overpriced cryptocurrencies that have a very promising future. By contrast, the time to aggressively load up on cryptos is when other investors are selling them in a panic.
History of The Fear and Greed Index
The fear and greed index is designed to help investors make better informed decisions on when to purchase or sell their cryptocurrencies.
One of the main reasons why markets crash is the constant oscillation between fear and greed. People become so fearful that they will sell all of their cryptos in one day because they are fearful of losing their money.
One needs to understand how markets work before they can devise a method to reduce or eliminate fear and greed from their investment decision making.
Components of the Crypto Fear and Greed Index
We are gathering data from the five following sources. Each data point is valued the same as the day before in order to visualize a meaningful progress in sentiment change of the crypto market.
But let’s list all the different factors we’re including in the current index:
Volatility (25 %)
We’re measuring the current volatility and maximum drawdowns of bitcoin and compare it with the corresponding average values of the last 30 days and 90 days. We argue that an unusual rise in volatility is a sign of a fearful market.
Market Momentum/Volume (25%)
Also, we’re measuring the current volume and market momentum (again in comparison with the last 30/90 day average values) and put those two values together. Generally, when we see high buying volumes in a positive market on a daily basis, we conclude that the market acts overly greedy / too bullish.
Social Media (15%)
While our reddit sentiment analysis is still not in the live index (we’re still experimenting some market-related key words in the text processing algorithm), our twitter analysis is running. There, we gather and count posts on various hashtags for each coin (publicly, we show only those for Bitcoin) and check how fast and how many interactions they receive in certain time frames). A unusual high interaction rate results in a grown public interest in the coin and in our eyes, corresponds to a greedy market behaviour.
Surveys (15%) currently paused
Together with strawpoll.com, quite a large public polling platform, we’re conducting weekly crypto polls and ask people how they see the market. Usually, we’re seeing 2,000 – 3,000 votes on each poll, so we do get a picture of the sentiment of a group of crypto investors. We don’t give those results too much attention, but it was quite useful in the beginning of our studies. You can see some recent results here.
The dominance of a coin resembles the market cap share of the whole crypto market. Especially for Bitcoin, we think that a rise in Bitcoin dominance is caused by a fear of (and thus a reduction of) too speculative alt-coin investments, since Bitcoin is becoming more and more the safe haven of crypto. On the other side, when Bitcoin dominance shrinks, people are getting more greedy by investing in more risky alt-coins, dreaming of their chance in next big bull run. Anyhow, analyzing the dominance for a coin other than Bitcoin, you could argue the other way round, since more interest in an alt-coin may conclude a bullish/greedy behavior for that specific coin.
We pull Google Trends data for various Bitcoin related search queries and crunch those numbers, especially the change of search volumes as well as recommended other currently popular searches. For example, if you check Google Trends for “Bitcoin”, you can get much information from the search volume, and we use that for our index.
Using the Index
When people make an investment in cryptocurrencies, they usually rely on fundamental or technical analysis. Technical analysis is not something that you can learn in a week or two. The markets are full of anomalies and one needs to have a good analytical mind to understand the myriad of factors and predict future market price action. Many people have made a fortune in the markets because of technical analysis and it certainly is something that you should seek to master for use when making investments. The crypto fear and greed index is just one of many tools of technical analysis.
Even though the cryptocurrency market is clearly in a bull market at the moment, the truth is that markets NEVER go in a straight line. There are rallies and there are corrections. Fear and greed will always be involved. It’s simply human nature. Someone who does not have a sound financial plan will make an investment that is driven by fear or greed, and they will most definitely lose money due to buying at the top (extreme greed) or selling at the bottom (extreme fear). This does not mean that every single day will turn out to be a loss; however, one needs to understand that they need to keep a strict eye on their cryptocurrency investments and only invest when they have a sound plan in place and have a proper exit strategy.
If you have a solid financial plan in place, you will not have to be concerned with the fear and greed factor and you will be able to invest according to your plan. By doing so, the individual will be able to take advantage of the bull market and create a position for themselves. This is what the individual needs to do in order to be successful in the cryptocurrency markets.