Résumé
The Fear and Greed Index provides a score from 0 to 100 of cryptocurrency market sentiment. It is based on the CNNMoney Fear and Greed Stock Market Analysis Index.
Fear (score 0 to 49) indicates undervaluation and oversupply in the market. Greed (score of 50 to 100) suggests overvaluation of cryptocurrencies and a possible bubble.
Note that the level of fear and greed can be part of your trading strategy when choosing to enter or exit the cryptocurrency market.
Introduction
When it comes to deciding whether to buy or sell in the cryptocurrency market, a good trader or investor will always look for useful data. There are charts to review, fundamental data to analyze, and market sentiment to consider. However, studying every indicator and index available is not the most efficient use of time. With the Fear and Greed Index, a combination of sentiment and fundamental indicators provide insight into the fear and greed of the market. While you shouldn't rely on this indicator alone, it can help you understand the overall sentiment of the cryptocurrency markets.
What is an index?
Traditionally, an index takes multiple data sources and combines them into a single statistical indicator. You may have already heard of the Dow Jones Industrial Average (DJIA), a famous index that tracks the stock market. The DJIA is a price-weighted combination of 30 major companies listed on numerous exchanges in the United States. Traders and investors can purchase the DJIA to gain combined exposure to the stocks of these companies.
The Fear and Greed Index is also a weighted measure of market data, but that's where the similarities end. The Fear and Greed Index is not something you can buy or a financial instrument. It is simply a market indicator that can complement your analysis.
What is a market indicator?
Market indicators make it easier for traders and investors to analyze market data. Indicators come in all forms of market analysis: technical analysis, fundamental analysis, and sentiment analysis. If you have experience with technical analysis (TA), you probably already have experience with indicators. These can be simple moving averages or complex chart patterns like Ichimoku clouds. AT indicators concern the analysis of prices, trading volume and other statistical trends.
Fundamental analysis indicators take a different approach. When you research a token or stock, you are essentially trying to determine the underlying fundamental value of the project. For example, your research might include the number of users and total market value combined into one metric.
Additionally, we have market sentiment indicators that measure the feelings and thoughts of investors and traders. The Fear and Greed Index is just one example. Other examples include Augmento's Bull & Bear Index and WhaleAlert which tracks large whale transfers in crypto markets. To some extent, cryptocurrency research relies heavily on social media, community, and public opinion analysis. This is why sentiment analysis can be useful for this asset class.
What exactly is a Fear and Greed Index?
CNNMoney originally created the Fear and Greed Index to analyze market sentiment for stocks. Alternative.me has since adapted its version to the cryptocurrency market.
The Fear and Greed Index analyzes a basket of different market trends and indicators to determine whether market participants are feeling greedy or fearful. A score of 0 indicates extreme fear, while 100 suggests extreme greed. A score of 50 indicates that the market is fairly neutral.
A fearful market could indicate that cryptocurrencies are undervalued. Too much fear in a market can lead to overselling and over panic. Fear does not necessarily mean that the market has entered a long-term downtrend. Instead, you can think of it as a short- or medium-term expression of market sentiment.
A greedy market is the opposite. If investors and traders are greedy, there is a possibility of overvaluation and a bubble. Imagine a situation where FOMO (fear of losing an opportunity) prompts investors to buy the market, thereby pushing the price of Bitcoin higher. In other words, increased greed can lead to excess demand, artificially inflating the price.
How does the Fear and Greed Index work?
Every day, Alternate.me calculates a new value between 0 and 100. As of July 2021, the Fear and Greed Index only uses information related to Bitcoin. The reason is BTC's significant correlation with the broader cryptocurrency market in price and sentiment. There are strategies for hedging other major currencies, including Ether (ETH) and BNB.
You can divide the index scale into the following levels:
0 - 24: extreme fear (orange)
25 - 49: fear (yellow)
50 - 74: greed (light green)
75 - 100: extreme greed (green)
The index calculates value by combining five different weighted market factors. Let's take a look:
1. Volatility (25% of the index). Volatility measures the current value of Bitcoin volatility with the averages of the last 30 and 90 days. Here, the index uses volatility as a representation of market uncertainty.
2. Market inertia/volume (25% of index). Current Bitcoin trading volume and market inertia are compared to the average values of the previous 30 and 90 days and then combined. Consistently high buying volume suggests positive or greedy market sentiment.
3. Social networks (15% of the index). This factor looks at the number of Twitter hashtags related to Bitcoin and, in particular, its interaction rate. In general, a consistent and unusually high number of interactions are identified more with greed than with fear.
4. Bitcoin market dominance (10% of the index). This measures the dominance of BTC in the market. The increase in market dominance shows new investments and the possible reallocation of funds from altcoins.
5. Google Trends (10% of the index). By examining Google Trends data for Bitcoin-related search queries, the index can provide insights into market sentiment. For example, an increase in searches for “Bitcoin scam” would indicate greater fear in the market.
6. Survey results (15% of the index). This entry is currently on hiatus and has been for some time.
Why is the Fear and Greed Index useful?
The Fear and Greed Index can be a valuable tool for tracking changes in market sentiment. Large changes in sentiment can allow entry or exit before the rest of the market follows the trend. We can see a brief example by looking at the evolution of the total capitalization of cryptocurrencies over the last three months compared to the index figures.
Point 1 corresponds to April 26, 2021, the low point of a significant change in the index value from 73 (greed) to 27 (fear). Point 2 shows the start of another slide on May 12, 2021, from 68 (greed) to 26 (fear). We can see if this has had an impact on the market by comparing these developments with the market capitalization of cryptocurrencies.
Point 1 again shows that we have a capitalization of $1.78 trillion on April 26 before evolving to a peak of $2.53 trillion on May 12. If you combine this with what we see above, you see a big swing in sentiment from greed to fear coinciding with a low point in crypto market cap. As the market becomes more greedy, the overall market capitalization increases until it reaches its maximum. At maximum, sentiment drops sharply again.
In our example, the index proved useful in finding a buying opportunity and predicting profit taking in the market. Using this index, you can check whether your emotional reactions are exaggerated or in line with the market. But will it always be useful in all situations? Probably not.
Can I use the index for long term analysis?
This indicator is not designed for long-term use in crypto market cycles. Within a bull or bear market, there are several cycles of fear and greed. These alternations are useful for swing traders who can benefit from them. However, for investors who want to keep their funds, it will be difficult to predict the change from a bull market to a bear market using the index alone. You will need to analyze other aspects of the market to get a long-term perspective.
As always, it is recommended not to rely solely on a single indicator or style of analysis. Be sure to do your own research (DYOR) before investing any money and only invest what you can afford to lose.
To conclude
The Fear and Greed Index is a simple way to bring together and summarize a comprehensive range of fundamental and market sentiment indicators. Rather than having to do these analyzes yourself, you can rely on the indicator to track social media, Google Trends, and other statistics for you. If you want to include it in your analysis, consider complementing it with other measures and indicators to obtain a more nuanced vision.
