Crypto Fear And Greed Index: How To Use It To Your Advantage
Summary
- The crypto fear and greed index is a metric designed to measure which sentiment is dominating the markets.
- When fear is the dominant sentiment, it can mean a good time to buy for the long term.
- When greed is the feeling du jour, it could mean it makes sense to let things cool off for the time being.
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Market sentiment can often be boiled down to one of two categories: fear or greed. This is the same for the stock market and crypto markets as well. However, it’s often even more of a “tell” in the crypto markets. And this is where the crypto fear and greed index can be a powerful tool. Especially for contrarian investors.
The crypto fear and greed index is a metric designed to measure which sentiment is dominating the markets. The beauty of this index is its simplicity. It ranks sentiment on a 0-100 scale. Zero means extreme fear is dominating. And 100 means greed is running rampant.
This index has recently been receiving lots of attention. This is because, for the first time in months, the index broke the Mendoza line and eked towards the greed side. In essence, this just means that the buying action is hot. And it could mean that prices might be nearing a peak in the short term.
On the other hand, when the index points toward the fear side, it could mean a buying opportunity is at hand. That being said, keep in mind this isn’t a perfect system. When the crypto fear and greed index shows fear, prices could still continue to trend downward for the unforeseen future. And the same goes for the greed side. Once a buying spree takes hold, it’s tough to tell how long it could last.
How The Crypto Fear And Greed Index Works
The crypto fear and greed index factors in several dynamics to draw its conclusion. In alphabetical order, they are:
- Dominance
- Market Momentum/Volume
- Social Media
- Surveys (Sometimes)
- Trends
- Volatility
Here’s how these factors are calculated and weighed…
Dominance measures how dominant Bitcoin is in the overall crypto market. When Bitcoin is getting all the attention, it can mean crypto markets are fearful. However, when more investors begin investing in altcoins, it can be a sign that they are more brave - and less fearful. This represents 10% of the index value.
Market momentum in the crypto fear and greed index is a calculation of momentum and trading volume of Bitcoin against the 30- and 90-day averages. In this case, high momentum and trading volume of Bitcoin are seen as an indication of fear. This has a weight of 25% of the index.
The social media aspect of the index tracks crypto mentions on various social media sites. More mentions mean an increasing participation in the market. And more mentions equal a higher score on the index. This metric has a weight of 15% on the index.
Sometimes surveys are employed. Naturally, more enthusiastic responses result in a higher score of the index. But these aren’t conducted before every issuance of the latest index result.
The trends metric of this index is a general look at cryptocurrency search volume on Google. More search volume leads to a higher score on the crypto fear and greed index. This carries 10% of the weight of this index.
Lastly, we have volatility. This is a comparison of volatility and declines in value compared to the 30- and 90-day averages. The higher the level of implied volatility, the lower the score of the index. This carries a weight of 25% on the index.
How To Use The Index As An Investment Tool
You can divide the crypto fear and greed index into four quadrants. A score of 0-24 indicates that extreme fear is taking hold of the markets. This likely means that prices are low. And that could indicate a buying opportunity before a price reversal takes place.
A score of 25-49 on the index means the markets are fearful. This simply means that fear is outweighing greed. And that means prices and interest in crypto are low but not terrible.
A score between 50 and 74 signifies greed is taking place in the crypto markets. This indicates there’s a lot of buying taking place and prices are on the rise. It’s seen as a bullish sign in general.
When the index comes in between 75 and 100, it likely means that the market is overheating. And this could be an indication that a correction is likely to take place soon.
What’s useful to know about the crypto fear and greed index is how much it has correlated with the price of Bitcoin over the past four years. When the greed is high, so has been the price of Bitcoin and vice versa.
For the reasons laid out above, this index can be a very useful tool for active traders. It’s become a particularly reliable technical indicator for the crypto markets. It’s also useful for buy-and-hold investors. When fear is the dominant sentiment, it can mean a good time to buy for the long term. And when greed is the feeling du jour, it could mean it makes sense to let things cool off for the time being.
The Bottom Line On The Crypto Fear And Greed Index
This technical indicator can obviously be a useful tool for investors, regardless of their trading tendencies. That being said, it should be taken with a grain of salt. There’s no surefire way to predict which way the markets are heading in the future.
Nonetheless, we’ve found the crypto fear and greed index to be a useful tool to add to our investment toolkit. It’s quite possibly the easiest way to see where market sentiment is. And it makes it that much easier to follow Warren Buffett’s words of wisdom. Because it can be quite lucrative to be fearful when others are greedy and greedy when others are fearful.
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Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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