Market movements are influenced by emotions, because humans are making decisions whether to buy hold or sell. We will not be going into the AI thingy now :)) The concept of the Fear and Greed Index was first developed by CNNMoney to model the traditional financial market’s mass psychology.
This is a sentiment analysis indicator that gives insight into the emotional state of the crypto market at any given time. Here is the link for you to access this, and if you click on it or see it right under, you’ll get a number between 0 and 100. 0, the lowest number, represents a state of extreme fear in the marketplace. The higher you go, the more greedy the market becomes, until you get to the extreme end at 100, where you’re in a state of extreme greed.
What you can notice right away is that this is Bitcoin fear and greed index, not crypto overall although it writes right under the bitcoin logo “Multifactortial Crypto Market Sentiment Analasys.” This is because bitcoin is still big enough to make almost half of the total cryptocurrency market cap, so whatever happens to bitcoin is impacting this total crypto market cap, and more often than not traders trade other cryptocurrencies according to bitcoin movements (stupid thing I know, and I explained here why).
The market is always in some kind of state somewhere between 0 to 100 at any given time, and there are a set of very basic assumptions that are caked into this metric that I think worth bringing up.
Two simple assumptions: number one, extreme fear can be a sign that investors are too worried, which could signal a buying opportunity. Number two, when investors are getting too greedy, that means the market is due for a correction.
By the way, if you’re wondering how on earth this indicator is created and what they’re relying on, they do have a section explaining that. They typically look at six things that include volatility, market momentum, social media surveys, bitcoin dominance levels, and overall trends.
Volatility (25%)
Volatility is measured by comparing the maximum drawdowns (drop in price) of Bitcoin at present, with its corresponding average drawdowns over the last 30 days. The developers argue that a rise in volatility (higher frequency in price drops) is a sign of a fearful market.
Market Momentum and Volume (25%)
The market momentum is measured by indicators such as the relative strength index, which infers that an asset is either overbought or oversold.
The average of this, along with the average trading volume over 30 days, is combined. An overbought market with a high volume would indicate a greedy sentiment.
Bitcoin Market Dominance (10%)
The developers believe that “a rise in Bitcoin dominance is caused by a fear of (and thus a reduction of) too speculative altcoin investments.”
On the other hand, if Bitcoin dominance shrinks, investors are willing to put their money into more volatile and speculative altcoins, a sign that the market is bullish on the overall crypto space.
Social Media Mentions (15%)
The frequency of various hashtags on Reddit and Twitter are analysed, along with social media engagement metrics such as the number of shares, likes, and comments.
“An unusually high interaction rate results in a growing public interest in the coin and in our eyes, corresponds to a greedy market behaviour,” according to the developers.
Search Trends (10%)
The developers used Google Trends to look at the relative trends of “Bitcoin” related search queries. The context of the search is often examined to avoid mistaking a negative sentiment for a positive one. An example that they gave is the query “bitcoin price manipulation” (+1550% up in 2018), which was deemed as a sign of fear in the market.
Surveys (15%) – paused
The developers no longer use surveys to measure the index, however “it was quite useful in the beginning of [their] studies”. With a sample of 2000-3000 votes, the developers could start getting a general reaction of the public towards the market activity.
As much as 60% of the score is based on technical analysis, which is supplemented by social network data, accounting for 40% of the index total score.
Now that we know what this metric is, let’s talk about how we can use it to become better crypto investor trader. Yup, trader, because this is not something on which you should rely on as investor, but if you are going to put money into the market soon anyway, then this tool can be helpful for gauging the overall emotional sentiment of the market. This understanding helps us figure out how currently crypto market feels.
For instance, if the price is going down and you’re feeling some anxiety or fear, there might be a desire to hit the sell button. But if you look at this indicator and see that the market is in a state of extreme fear, say, with a score of 15 or 16, which would represent extreme fear, you can think: “Well, actually, it’s not just me then. The whole market is in the state right now.”
If you were to take expressions like Warren Buffett’s, who says, “Be fearful when others are greedy and greedy when others are fearful,” that might actually signal a good buying opportunity because there’s so much scared money out there.
It’s important to understand that this isn’t always so clear-cut. It’s not such a straight “in times of fear, buy and in times of greed, sell” strategy. In my experience with crypto, when you’re in a bull market, a sustained uptrend of higher highs and higher lows, these kinds of indicators can signal greed or extreme greed for very long periods of time, and the price can still go up enormously, as we witnessed in 2017.
Conversely, when you’re in a bear market, a long-term downtrend of lower highs and low lows, things can actually stay in fear or extreme fear for a pretty long time, and again, prices can just continue falling. You’re not going to see a sudden, sharp rise in the price just because we’re in a fear stage.
Bearing all of that in mind, you might be wondering, “Isn’t this indicator pointless?” Then, how could you actually use it if it can mislead you during the greedy times in bull markets and the fearful times in the bear markets?
My answer to that would be that I still think you can use this in a really clever way if you reverse the thinking somewhat. In other words, this is very useful for buying the dip moments in bull markets and for selling the rally moments in bear markets.
Let’s take a bull market, for instance, where the crypto market once again is in a sustained, prolonged period of higher highs and higher lows. You might be wondering when to accumulate and at what time to buy the dip. What you can do, once again, if you know that we’re in the bull market, is to look for these rare opportunities, these rare dips where you know a 30-40% correction, which is not unusual.
At that point, you can see that this indicator might actually point towards fear, or even extreme fear occasionally. We saw that in 2017 with a lot of the third around China ban and whatnot. It’s during those times that you can use this indicator as a signal to potentially buy the dip.
You can apply this idea the complete opposite way as well.
Whenever we’re in the crypto bear market where we have a sustained, long-term trend of lower lows and lower highs, you know confirmed downtrend. It’s at the points where occasionally you get a surge in the price or some kind of rally, whenever that signals a greedy or a period of extreme greed, at that point, once again, it could potentially signal a time to sell because those go against the trends somewhat.
If you’re in the context of a larger macro bear or bull market, the trend is likely to continue, and so that can be your signal when the emotional market switch somewhat. At least short term, that’s the point to which you can take advantage and use this indicator to benefit yourself financially. By doing that, you’re essentially exploiting the emotions of the market while remaining relatively safe within the confines of the long-term uptrend or long-term downtrend.
That’s a really interesting way to use this metric to your advantage. In other words, to summarize, you don’t want to necessarily look at periods of greed in bull markets, except for very rare periods of extreme greed towards the blow-off top phase in the cycle, which we do see occasionally. We saw it at the end of 2013 and end of 2017, but typically you want to ignore greed in bull markets because that can happen for long periods.
However, you can look at periods of fear or extreme fear within the bull market as buy-the-dip opportunities.
You can do the exact reverse in bear markets as well. Other than the extreme capitulation events that you see sometimes, like in December 2018, you don’t want to pay attention so much to the fear. Instead, you want to pay attention to the greed and periods of perhaps extreme greed within the confines of a long-term downtrend in a bear market.
It’s an interesting way to use this tool to your advantage and benefit from some form of emotional sentiment analysis in the crypto space.
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