Investing is painfully emotional and those emotions can be the reason why so many people lose money in the market. Berkshire Hathaway CEO, Warren Buffet, once said: “[Be] fearful when others are greedy, and greedy when others are fearful.”
With that in mind, let’s take a look at the crypto fear and greed index.
What Is the Crypto Fear and Greed Index?
The crypto fear and greed index helps you determine when the cryptocurrency market is fearful and when it’s greedy. It shows the market’s attitude simply on a speedometer. A score of 100 represents “extreme greed”, while a score of 0 represents “extreme fear”.
This can be used to measure if the market is fairly priced. The closer the index is to 0, the more likely the market is to be undervalued, due to fear in the market. On the other hand, the closer it is to 100, the more likely it is that the market is overvalued.
Fear and greed indexes were first created by CNN Money to measure the general stock market. But in 2018, Alternative.me created the crypto fear and greed index, which analyzes emotions and sentiments surrounding Bitcoin and other large cryptocurrencies.
What Is Alternative.me?
Alternative.me is a platform that helps users find alternatives to popular software, (such as Spotify), and products, (such as Elastic No Tie Shoelaces). It now has a crypto section on its site that homes crypto market information, most notably the crypto fear and greed index.
How Does the Crypto Fear and Greed Index Calculate the Market?
The crypto fear and greed index uses six different factors to determine the index score:
- Market Momentum/Volume
- Social Media
These factors are not weighted equally and all account for different aspects of the market. It’s important to note that all data gathered is in relation to Bitcoin. Let’s take a closer look…
Volatility accounts for 25% of the index.
The current rise or fall of Bitcoin is compared to the corresponding average values of the last 30 and 90 days.
Alternative.me has stated that “an unusual rise in volatility” is deemed a sign of a fearful market. Suggesting that a stable increase in volatility (or no move in volatility) is seen as indicative of a greedy market.
Market Momentum and Volume
Market Momentum and volume account for 25% of the index.
The current volume and market momentum are also compared to the last 30 and 90 day average values.
When there is high buying volume in a market with positive momentum, you can safely conclude that the market is acting with greed.
Social media accounts for 15% of the index.
At the current moment, this only includes Twitter analysis. However, Alternative.me is experimenting with Reddit sentiment analysis as well.
The number of posts on Bitcoin-related hashtags, as well as the amount of interaction these tweets get (and how fast they get them) are monitored.
As you would expect, the higher the volume of tweets and interactions, the more greedy the market is assumed to be.
Surveys account for 15% of the index. However, this is currently paused.
This was mostly used at the beginning of the crypto fear and greed index, and has since been paused. Alternative.me has said, “We may reactivate it, but we cannot estimate a time frame for that.”
Dominance accounts for 10% of the index.
This measures the dominance of Bitcoin (this may change as they offer alternative indexes tracking different coins) compared to the rest of the market.
When Bitcoin’s dominance increases, it is assumed that the market is fearful as people are reducing their exposure to more speculative alt-coins. On the other hand, when Bitcoin’s dominance decreases it is a sign of greed as more investors put their money in speculative alt-coins.
Finally, trends account for 10% of the index.
Google Trends is used to measure the popularity of Bitcoin-related queries.
You can use this to measure the general interest in Bitcoin via search volume. But also, the anything people are Googling around crypto. For example, if “how to buy Bitcoin” is a trending query, it’s a clear sign of a greedy market.
Please note that the CNNMoney index uses different factors.
How Do Investors Use the Crypto Fear and Greed Index?
The creators of the fear and greed index said themselves, “Extreme fear can be a sign that investors are too worried. That could be a buying opportunity. When investors are getting too greedy, that means the market is due for a correction.”
Some inventors use this as a tool when investing for this exact reason. Such as the quote we previously used says, “be greedy when others are fearful”. Thus, investors will use scores close to 0 as a point of entry and high scores as a selling point.
Take a look at the graph below that shows Bitcoin’s price with the fear and greed index score color-coded. You can see that, generally, red marks are followed by a bull run, and deep green marks are soon followed by a drop in price.
The Pros and Cons of Using the Fear and Greed Index
- Helps remove emotion from your trading
- Historically, the index has performed well
- Is a tool that is also used in traditional stock market
- Should not be the sole reason for an investment
- May oversimplify things
- Not 100% accurate
- Could fail to perform well in the future
To conclude, the crypto fear and greed index is a good tool for investors to use as a way to help remove emotion from their trades. Historically, it has performed well both in the crypto market but also in the traditional stock market.
However, smart investors will use this as one of many tools rather than a law they invest by. As always, do your own research and think for yourself. Despite performing well in the past, there is a chance that the crypto fear and greed index could fail to deliver in the future.
Alternative.me itself even claims that the index is not investment advice. Stating, “The information provided on this website does not constitute investment advice, financial advice, trading advice, or any other sort of advice and you should not treat any of the website’s content as such.”
This article is a part of the Hashnode Web3 blog, where a team of curated writers are bringing out new resources to help you discover the universe of web3. Check us out for more on NFTs, DAOs, blockchains, and the decentralized future.