What Is the Crypto Fear and Greed Index?
Emotions are a common driver of the crypto market. Investors might throw caution to the wind when the market is going up because of fear of missing out (FOMO). At the same time, they might panic sell if the prices are dropping.
The crypto fear and greed index measures crypto market sentiment using data and market indicators. This article explores the crypto fear and greed index, how it is calculated and how you can consider it in your investment decisions.
How Does the Crypto Fear and Greed Index Work?
Initially, the fear and greed index was a stock market indicator created by CNN Money. The index attempts to gauge the emotions driving the market and whether stocks are fairly priced.
However, because of differences in the factors affecting fear and greed in stock markets and crypto markets, a similar index was developed and tailored solely to the cryptocurrency market. To track sentiment in this industry, alternative.me developed a working, widely-used model for calculating the crypto fear and greed index.
The crypto fear and greed index uses market trends and social signals such as volatility, momentum, and social media to determine a fear and greed level. Several data sources are distilled down to a numeric value to represent current fear/greed levels.
Why Measure Fear and Greed?
Investors are prone to various emotions that could affect their ability to make rational decisions. This susceptibility is especially relevant in turbulent markets like cryptocurrencies. By tracking fear and greed and representing these emotions numerically, investors have another tool to evaluate current market conditions.
Establishing an empirical method using data to gauge market sentiment could improve the decision-making processes of crypto market participants and, hopefully, their profitability.
How the Crypto Fear and Greed Index is Calculated
The crypto fear and greed index is among many signals that can help investors make suitable crypto investments.
The index hinges on two fundamental assumptions — extreme fear might signal that ‘the bottom is in’ and represent an opportunity to buy, and extreme greed could signal that ‘the top is in’ and it’s the optimal time to sell.
The alternative.me crypto fear and greed index analyzes Bitcoin and breaks down the results into a digestible ranking ranging from 0 to 100. Zero represents the most severe level of fearful sentiment, while 100 is the pinnacle of extreme greed. The index levels can be broadly separated into these categories:
A score from 0-24 indicates Extreme Fear; 25-49 is Fear; 50-74 marks Greed; and 75-100 is designated as Extreme Greed.
Here are the factors used to calculate the crypto fear and greed index:
Current Bitcoin volatility and the maximum drawdown (percentage price difference between a peak and the subsequent trough) is compared with corresponding average values of the last 30 and 90 days. This data point is weighted 25%, with an increase generally signaling a fearful market.
Market momentum/volume compares the current volume and market momentum against the last 30- and 90-day average values. Repeated high volumes in a positive market indicate a bullish or greedy market sentiment. Momentum/volume data carries a weight of 25%.
A text-processing algorithm scours Twitter for hashtags and mentions of digital assets. Bitcoin mentions are shown. The algorithm counts relevant posts and analyzes the speed of engagement to determine how fast information is distributed throughout the crypto community. High public interest may show up through positive interaction rates on a topic, which can be interpreted as a sign of greedy market sentiment. Social media represents 15% of the total index value.
Surveys account for direct public opinion on crypto market sentiments. Additionally, alternative.me, in partnership with a sister site, strawpoll.com, conducts weekly polls asking the public about their general impression of the crypto market. The polling participants typically turn in about 3,000 votes on each survey, providing insight into group sentiment. The survey factor weighs in at 15%, although alternative.me has recently paused using this factor to calculate the fear and greed index.
The market dominance of a coin can be calculated by its market cap share of the overall crypto market. For example, the dominance of Bitcoin is calculated by dividing the Bitcoin market capitalization by the market capitalization of the entire crypto market. Fearful market sentiment usually results in increased Bitcoin dominance. Investors, wary of altcoins and their speculative nature, often reduce their investment in altcoins in favor of the historically less-volatile bitcoin, which could be perceived as a safer crypto investment. This mimics the transition traditional investors make from growth stocks to value stocks when recessionary conditions prevail.
In contrast, when Bitcoin dominance starts to slide, investors are becoming greedier by snapping up riskier altcoins, hoping to cash in on the next bull run. The dominance factor holds a weight of 10%.
The trend factor involves pulling and analyzing google trend data for various Bitcoin-related searches. The search volume changes are significant, and so are Google-recommended related popular searches for similar keywords. An increase in negative queries indicates pervasive fear in the market. This factor has a weight of 10% in the index.
Keep a Pulse on Crypto Fear and Greed
When it comes to money, it's challenging to dissociate your emotions from decision making. The crypto fear and greed index is a distillation of key data sources meant to analyze market sentiment and offer a single dependable figure. This analysis can assist you in making informed decisions without relying on potentially biased feelings.
Keep in mind that the calculated index is based on market data and the reactions of various investors. As a result, the index is a lagging indicator and therefore cannot guarantee future market performance.
The index is currently limited to Bitcoin, though alternative.me plans to offer it for other major cryptocurrencies soon. Investors can also apply similar principles to other coins as an indicative metric. As with any other investment, you must do your own research.
Frequently Asked Questions
Q. What determines the crypto fear and greed index score?
A. The crypto fear and greed index measures the sentiment of market participants based on metrics such as market momentum/volume, volatility, and the dynamics of social media interactions.
Q. Is the fear and greed index reliable?
A. The fear and greed index can sometimes be a reliable tool for making investment decisions. It can be used by long-term investors to get an indication of market sentiment.
Q. How to check the fear and greed index?
A. You can check the crypto fear and greed index by visiting alternative.me. The crypto fear and greed index chart shows a history of index levels.
Recommended reading: Timing the market vs. time in the market
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