“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful”
Warren Buffet
What is the Bitcoin and Crypto Fear and Greed index?
This daily updated indicator aims to display the current sentiment, particularly the two primary emotions we can observe in the market: fear and greed. This is only concerning Bitcoin and other significant cryptocurrencies, which can help detect overall sentiment.
The values are shown from a scale from 0 to 100, with 0 being “Extreme Fear” and 100 being “Extreme Greed.”
The concept of the fear and greed index for bitcoin and other traditional assets is not overly complicated. It is intended to gauge whether assets are reasonably priced, fear being a critical emotion that drives down prices and greed tends to do quite the opposite.
Typically one would say that extreme fear is when there is a higher probability for a good buying opportunity while extreme greed makes for a higher likelihood for a good selling opportunity.
Measuring sentiment itself is nothing new, it is often done by the subjective impression one gets by those around oneself and the sentiment you may gather from reading what is written in different communities. The fear and greed index tries to filter out subjective approaches by being based on data sources to attempt to create more stable and accurate assessments.
Emotional and Irrational Behaviour
Humans are very emotional beings in general, even though in Finance and Economics related subjects one is accustomed to making assumptions that the investors or markets are rational, one thing they funnily often are not. This is particularly true when money comes into play, it exceedingly more difficult to remain calm and level headed. The emotion towards loss tends to be amplified more than the euphoric sensation of winning.
This is why a fear and greed index can be useful if your natural senses of sentiment are distorted. It allows us to view the sentiment from a system which stores no emotion or directional bias, only data. Now, the quality of the data is naturally up for debate. Nonetheless, if you need a rough estimation on the market, it can be a useful tool for some.
Data Sources
The fear and greed index for Bitcoin and crypto gathers data from five sources that drive the indicator. Together they are collected and visualized to display the sentiment change in an easy to read way.
The following five data sources are used, and their respective weighting in the sentiment is displayed:
Bitcoin Volatility (25%)
The current volatility and drawdown are measured and compared to the average of previous periods consisting of 30 days and 90 days. Any unusual rise in volatility is interpreted as a sign of fear in the market.
Momentum and Volume in the Market (25%)
The current volume observed in the market and momentum compared to the same 30 days and 90 days average is used to identify high buying volumes daily, which suggests that the market may be on the greed side of the sentiment indicator.
Sentiment on Social Media (15%)
This is a live analysis taken from twitter, where posts, hashtags, etc. are checked for how many interactions occur in a specific time period. If there is a vast number of interactions, it tends to hint towards a greedy market.
Suverys (15%)
This method of gathering market sentiment is currently not active.
Dominance (10%)
Dominance is defined by the market cap of the crypto market, if Bitcoin has a high dominance rate, it has a market cap of the available total crypto market capital. What is measured here is the rise of dominance, which in this index is believed to be caused by fear since it tends to lead to a reduction of alt-coin investments. The opposite often happens when Bitcoin dominance shrinks, and we see more greedy behavior in the market towards alt-coins.
Trends (10%)
Google Trend data is analyzed for searches related to Bitcoin. Rises and decline in bullish or bearish sentiment searches are used to help gauge sentiment in the index.
Final Thoughts
I would never recommend basing one’s strategy on such indexes. It is merely meant to gauge the sentiment in the market and thus does not necessarily have strong predictive ability.
Overall from past historical moments, people who had bought Bitcoin when there were extreme levels of fear and sold when there was extremes level of greed would have done quite well. This hardly means it is flawless, in 2017, there were excessive levels of greed very early on in the bull run. However, it didn’t stop the impressive bull run from happening. Meaning, following this blindly can never be commended.
It is essential to underline that I do not have direct access to the methods the people behind this index are extrapolating their data and choosing populations for sentiment analysis in the relevant data sources. This means it does not allow me to quality check their methods or if they follow standard scientifical rules of data interpretation.
It is also worth noting that there are similar fear and greed indexes out there that display slightly different fear and greed numbers, which has to do with how the data is weighted and how the information is collected.
Even though it can be helpful to use the index, I still believe that the best way to gauge sentiment is to surround yourself with other traders and to view the sentiment in different areas of crypto, whether it be discord, telegram, twitter or other communities.