Crypto fear and greed index is one the most popular analytics tools leveraged by investors to buy and/or sell cryptoassets. The increasing reliance on the multifactorial instrument comes as the crypto market is notorious for its high volatility, making it challenging for investors to navigate.
Notably, the price fluctuations in the crypto market are a result of market participants’ differing trade decisions, often fueled by their emotions. Accordingly, the crypto fear and greed Index helps provide insights into the sentiments and trends in the crypto market.
Here, we will look at the significance of the crypto fear and greed index and how investors can wield it to make profitable investment decisions. This article also discusses how the market sentiment indicator works and the factors that affect it.
What is Crypto Fear and Greed Index?
Investing in cryptocurrency can be a wild ride as assets’ prices can skyrocket or crash within seconds, minutes or hours. The emotions of market participants are one of the most important factors that can influence market behaviour. Fear and greed are the two most notable emotions that can influence the decisions of crypto traders.
This led to the introduction of the crypto fear and greed index, which measures market participants’ emotions at a particular time, providing a numerical score between 0 to 100. In particular, the index categorizes market sentiment from extreme fear to extreme greed.
It bears mentioning that fear and greed are at opposite ends of the emotional spectrum when it comes to crypto investing. While fear is a negative emotion that can cause one to adopt a defensive posture, greed is a positive emotion that can cause an investor to adopt an aggressive attitude.
When prices fall, fear can cause investors to panic and sell their crypto holdings at low prices. Meanwhile, greed can cause investors to hold onto their investments for too long, missing out on gains or suffering significant losses.
These two emotions can also interact in complex ways, resulting in a vicious market cycle. For example, if prices suddenly fall, investors may sell their holdings, causing the price to fall even further. This can cause even more fear, resulting in a downward spiral of selling and further price drops.
On the other hand, when prices surge, greed can cause investors to hold onto their investments for a long time without selling. However, whenever they decide to sell off, it can result in a sudden price drop.
How Crypto Fear and Greed Index Works
The crypto fear and greed index methodology is based on a scale of 0 to 100, with 0 representing extreme fear and 100 depicting extreme greed. The index is calculated using a weighted combination of seven indicators. Volatility, market momentum, social media sentiment, Google trends, bitcoin dominance, market capitalization, and trading volumes are among the indicators.
Based on the data it collects, the index generates a number between 1 and 100. If the score ranges from 0 to 24, the market is experiencing “extreme fear.” This entails that more market participants are selling their cryptoassets at that particular time.
A score of 25-49 indicates that the market is in a state of ‘fear,’ meaning that investor interest has toned down. This could be a good buying opportunity for investors with a high-risk tolerance.
Meanwhile, a score of 50 indicates that the market is “neutral“, meaning neither fear nor greed exists in the crypto market. However, a score of 51 to 74 indicates that investors are becoming greedy and buying cryptoassets steadily.
Notably, a score between 75 to 100 on the index indicates “extreme greed.” This score implies that the market is in a bubble as greed enters a high frequency. When the market becomes overly greedy, it could be a good time to take profits.
Index Data Sources
Volatility is a key indicator influencing the crypto fear and greed index. When the market experiences large price swings, volatility rises, leading to increased fear or greed. According to Alternative.me, volatility influences the index number by 25%. Another important indicator is market momentum, which measures the speed and direction of price movements.
When prices rise quickly, it can lead to increased greed, while falling prices can lead to increased fear. High trade volume and market momentum are viewed as metrics that raise the index output. Momentum/volume accounts for 25% of the index score.
Bitcoin dominance also influences the index score. Notably, bitcoin dominance is the percentage of the total crypto market capitalization that BTC represents. When bitcoin dominance is high, it can lead to increased confidence and greed, whereas when it is low, it can lead to increased fear and uncertainty. Dominance accounts for 10% of the index score.
Meanwhile, social media accounts for 15% of the index score. The social media index keeps track of bitcoin mentions and hashtags. Increased mentions and hashtags are interpreted as increased market participation, increasing the final index output.
Another important factor that affects the index is surveys. Every week, the index conducts large, market-wide surveys. Each survey typically has 2,000-3,000 participants. The index score increases based on how many people are enthusiastic about the market – a key indicator of greed.
How to Leverage the Crypto Fear and Greed Index
Over the years, people often get greedy when the market is rising which results in FOMO (Fear of missing out). Likewise, investors tend to sell their cryptoassets irrationally when they see red candles. However, knowing how to leverage the crypto fear and greed index can help you navigate the market profitably.
As mentioned, 0-24 represents extreme fear, 25-49 suggests a nervous cryptocurrency market, 50-74 demonstrates that greed is gradually taking over the market while 75-100 indicates that extreme greed exists in the market.
So how can you take advantage of these metrics when trading? When the market is in fear or extreme fear, it could be seen as an opportunity to invest because crypto prices are usually low.
On the other hand, when the market looks exceedingly bullish, some crypto traders often take profits while leaving the initial capital to keep producing more profits. However, you mustn’t let greed conquer you during this season. Why?
When the market becomes exceedingly greedy, it’s usually an indication that a correction is around the corner. Therefore, one of the best opportunities to sell your investments could be during these extreme greed moments.
The fear and greed index is an efficient instrument for assessing the crypto market sentiment. By assessing market participants’ emotions, this index gives significant insights into market patterns, helping investors to make rational decisions. Said differently, the crypto fear and greed index can help investors increase their profits and prevent losses.
While it should not be relied upon absolutely, the index is a great tool for investors who wish to remain ahead in the crypto market. As the cryptocurrency market grows, it is apparent that the crypto fear and greed index will continue to be a valuable tool as it offers useful insights into crypto market cycles and investor sentiment at a particular time.