Investing is a source of painful emotions and these emotions may be the reason why so many people lose money in the market. Warren Buffet, CEO of Berkshire Hathaway, 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 Cryptocurrency Fear and Greed Index.
What is the Crypto Fear and Greed Index?
The Cryptocurrency Fear and Greed Index helps you determine when the cryptocurrency market is fearful and when it is greedy. It shows the market 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 whether the market price is fair. 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.
The fear and greed indices were first created by CNN Money to measure the general stock market. But in 2018, Alternative.me created the crypto fear and greed indexwhich analyzes emotions and sentiments surrounding Bitcoin and other major 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 No-tie elastic shoelaces). It now has a crypto section on its site that hosts information about the crypto market, including the Crypto Fear and Greed Index.
The company is made up of two men, Gregor Krambs, the creator of Strawpoll.comand Victor Tobies, web developer and creator of ThunderCheck.org.
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:
- Volatility
- Market dynamics/volume
- Social networks
- Investigations
- Dominance
- Tendencies
These factors are not equally weighted and all take into account different aspects of the market. It is important to note that all data collected relates to Bitcoin. Let’s take a closer look…
Volatility
Volatility explains 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 said “an unusual rise in volatility” is considered a sign of a fearful market. Which suggests that a stable increase in volatility (or lack of movement in volatility) is considered a sign of a hungry market.
Market dynamics and volume
Market dynamics and volume explain 25% of the index.
The current volume and market dynamics are also compared to the average values of the last 30 and 90 days.
When there is high buying volume in a market with positive momentum, you can safely conclude that the market is acting greedily.
Social networks
Social media accounts for 15% of the index.
At the moment this only includes Twitter analytics. However, Alternative.me is also experimenting with sentiment analysis on Reddit.
The number of posts on Bitcoin-related hashtags, as well as the number of interactions those tweets get (and how quickly they get them) are monitored.
As one would expect, the higher the volume of tweets and interactions, the more greedy the market is assumed to be.
Investigations
The surveys represent 15% of the index. However, it is currently on hiatus.
Alternative.me possesses Strawpoll.com; using this platform, they conduct weekly crypto market surveys. Each poll attracts 2,000 to 3,000 votes which are used to indicate market sentiment.
This was primarily used in the early days of the Fear and Greed crypto index, and has since been suspended. Alternative.me said“We can reactivate it, but we cannot estimate a time frame for that.”
Dominance
Domination represents ten% of the index.
This measures the dominance of Bitcoin (this may change as they offer alternative indices tracking different coins) compared to the rest of the market.
When Bitcoin dominance increases, it is assumed that the market is fearful, as people reduce their exposure to more speculative altcoins. On the other hand, when Bitcoin's dominance declines, it is a sign of greed, as more and more investors invest in speculative altcoins.
Tendencies
Finally, trends explain ten% of the index.
Google trends is used to measure the popularity of Bitcoin-related queries.
You can use it to measure general interest in Bitcoin via search volume. But also everything people search on Google around crypto. For example, if “how to buy Bitcoin” is a trending query, that’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 themselves said: “Extreme fear may be a sign that investors are too worried. This could be a buying opportunity. When investors become too greedy, it means that the market is due for a correction.”
Some inventors use it as a tool when investing for this very reason. As the quote we used earlier says, “be greedy when others are afraid.” So, investors will use scores close to 0 as an entry point and high scores as a selling point.
Take a look at the chart below which shows the price of Bitcoin with the color coded Fear and Greed Index score. You can see that, generally, red marks are followed by an uptrend, and dark green marks are quickly followed by a decline in price.
Source: lookintobitcoin.com
The Pros and Cons of Using the Fear and Greed Index
Benefits
- Helps take emotion out of your trading
- Historically, the index has performed well
- Is a tool also used in traditional stock market
The inconvenients
- Should not be the only reason for an investment
- Can oversimplify things
- Not 100% accurate
- May not be successful in the future
Conclusion
To conclude, the Crypto Fear and Greed Index is a good tool that investors can use to help remove emotion from their trading. Historically, it has performed well in both the cryptocurrency market and the traditional stock market.
However, smart investors will use it as just another tool rather than a law by which they invest. As always, do your own research and think for yourself. Despite performing well in the past, it is possible that the fear and greed index of cryptocurrencies will not be up to par 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, business advice or any other type of advice and you should not treat any content on the website as such.”
This article is part of the Hashnode Web3 Blog, where a team of selected editors offers new resources to help you discover the world of web3. Visit us to learn more about NFTs, DAOs, blockchains and the decentralized future.