Even the most solid investment strategy can be ruined in seconds by the fear and greed of other market participants. How do we measure that? By using the crypto Fear and Greed Index, of course!
These market sentiments can be triggered by various stimuli, such as the “fear of missing out” (FOMO), on the next big thing. This can make investors concerned that the price of a hyped asset will soar before they buy in. They then flood the market with buy orders and, ironically, cause the price hike they were actually worried about.
Fear and greed can also be seen when prices rise and stay high. Holders fear inflated values will put potential buyers off and that they may never realise their profits. So they sell, an action that can, in itself, see an asset value fall.
The Crypto Fear and Greed Index
How can we measure investor sentiments when they directly impact an asset’s price behaviour?
That was the starting point for the crypto Fear and Greed Index so many people refer to today.
That approach already existed within the stock markets. The Volatility Index is used by analysts to try and understand the level of investor panic in the US stock market during a crisis.
The Volatility Index, or VIX, uses derivatives trading volume to create an index and moves in tandem with institutional and high-net-worth investors’ market sentiments and investment strategies.
VIX can show how sentiment directly impacts an asset’s price and the market’s behaviour.
The cryptocurrency Fear and Greed Index is a similar tool used to gauge investor sentiment in the cryptocurrency market.
What Exactly is the Crypto Fear and Greed Index?
The crypto Fear and Greed Index usually generates a number between one and 100. One indicates that the crypto market is experiencing extreme fear (meaning people are selling). When the index says 100, it indicates that the market is experiencing extreme greed (meaning people are buying).
As a general guide, when the index value is at one, it indicates a good time to buy. This is because “extreme fear” means people are afraid to buy and there are opportunities to invest at low prices.
As American investment guru Warren Buffett once said, “Buy when there’s blood in the streets”.
Of course, you are gambling that the prices will recover to bring you profit and not keep falling.
When the index is at 100, it is considered “extreme greed”. This is generally interpreted as a sell signal. Consider this a stampede of people trying to get into a hot market at any cost, hoping to profit from the meteoric rise that investors witnessed with meme stocks in 2021. When prices rise quickly, there is a chance that they will fall just as quickly.
To put it simply: when the crypto Fear and Greed Index value is low, it may indicate that the crypto price will rise soon, and when the index value is high, it may mean that the crypto price will fall soon.
How is the Crypto Fear and Greed Index Calculated?
How do they come up with the final figure? Numerous factors influence the result.
Volatility: The index compares volatility and maximum drawdowns (value declines) to the 30-day and 90-day average volatility and drawdown numbers. Higher volatility is associated with fear and raises final output. Volatility accounts for 25% of the index’s value.
Momentum/volume: The index measures the market’s current momentum and volume. Again, in comparison to the 30-day and 90-day averages. High volume and momentum are considered negative metrics that raise the final index output. Momentum/volume accounts for 25% of the index value.
Social media: The index tracks mentions and hashtags and compares them to historical averages. Increased mentions and hashtags are interpreted as increased market participation, resulting in an increase in the final index output. Social media accounts for 15% of the index value.
Surveys: On a weekly basis, the index conducts extensive, market-wide surveys. Each survey typically has 2,000-3,000 participants. More enthusiastic survey results drive the index even higher, indicating market greed. Surveys account for 15% of the index value.
Dominance: The index measures Bitcoin’s market dominance. According to the index, the greater Bitcoin’s dominance, the more fearful the market. The market is acting bravely and not fearfully when alternative coins (altcoins) gain market share. The market becomes more greedy as bitcoin’s dominance declines. Dominance accounts for 10% of the index value.
Trends: The final value of the index includes Google trend numbers. The greater the search interest in cryptocurrency, the greater the amount of greed seen in the market. Trends account for 10% of the index.
Conclusion
To summarise, the Crypto Fear and Greed Index assesses investors’ fear and greed in the cryptocurrency market.
This is, however, only a tool to track investors’ sentiments in the market. It is a helpful indicator, but to truly identify buying and selling signals, there are several factors to consider.
Remember, the index is indicative only. Buying at a low price doesn’t guarantee a profit, and selling when prices get too hot doesn’t ensure your money is saved.
Before investing in cryptocurrency, do your own research, consider multiple sources of information, and never invest more than you can afford to lose.
