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Fear and Greed Index- What It Is and How and When to Use It?

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Fear & Greed Index is one of the most commonly used sentiment tools in the cryptocurrency world. Many analysts, traders or investors have been using it to portray what is the current mood in the markets and what does that mean for trading or investing strategies. Today, we will look at this index in-depth, covering not only what this index is, but also looking at some important values from the past as well as analyzing the current state and the long term perspective that this indicator can provide. 

Fear & Greed Bitcoin Index – best sentiment tool in the market?

The Fear & Greed Index was created on 1st of February 2018 and since then it has gathered a lot of attention. Analysts in the crypto world use it to show what the current sentiment is, what it can mean and what insights can we gain from it.

Fear & Greed Bitcoin Index is one of the most used tools in the cryptocurrency market. This is not only due to its very simple approach to gathering information, but also due to easy-to-understand presentation of information, which are really simple to digest. So how does Fear & Greed Index work and what it represents?

Fear & Greed Index is an output of the analysis of different market segments and tools that is brought together to produce one number that represents the current market sentiment. This number is a value ranging from 0 to 100, with 0 being extreme fear and 100 being extreme greed. None of these extremes have been met yet. The lowest value that has ever been seen was 5 and the highest was 95. We will talk about these events in more detail later, but first, let’s look at what exactly does the Fear & Greed Index consist of.

What is the Fear & Greed Index looking at?

As explained on its website, Fear & Greed Index is a combination of 6 factors, each consisting of a different percentage weight that it represents in the index. What are these factors?

Volatility (25%)

The index compares the current daily volatility and maximum drawdowns of Bitcoin with the corresponding values of the last 30 and 90 days of the similar metrics. The logic behind this is that an unusual rise in the volatility might lead to a sign of a fearful market, thus low index values can be spotted.

Market Momentum/Volume (25%)

The same logic is also applied for market momentum and current volumes seen by exchanges. For instance, if the buying volumes across exchanges are high, this is interpreted as a positive sign and the index can flash a higher value, which is taken as more bullish and also more greedy.

Social Media (15%)

Interestingly enough, the index also looks for the overall sentiment that is spreading around social media. As we know, the cryptocurrency community is extremely active on social media, such as Twitter or Reddit. While the Reddit index is still not live, the analysis of hashtags, interactions or post counts for Bitcoin on Twitter is fully running. For instance, if there is unusually high activity, the social media part of the index can push the overall value higher, to the region of “more greedy” market behavior.

Surveys (15%)

Another part of the index were surveys. These were done on a weekly basis and were mostly helpful for seeing the trends and overall sentiment of the cryptocurrency investors and  traders. As of now, the surveys section of the index is paused and not used.

Dominance (10%)

Dominance, especially for Bitcoin, is a highly followed metric that shows how much of the overall Bitcoin market is captured by the biggest cryptocurrency and how much belongs to altcoins. Interpretation of this metric might be a bit more complex, but it is important for the overall understanding of the index. Basically, the higher the dominance of Bitcoin, the lower is the investment in altcoins. This can be caused by fear, since investors are moving money from more speculative and risky investments (altcoins) to rather safe cryptocurrency (Bitcoin). Since Bitcoin is the oldest, biggest and best known cryptocurrency, it has earned a status of a “safe-haven” asset in this sphere. Thus any increase in the dominance might be caused by the overall fear in the market, while decrease in the Bitcoin dominance might be due to more risk-on, greedy behavior from investors.

Trends (10%)

The last piece of this index is looking at different trends that are emerging. This is mostly related to the search queries for Bitcoin, where tools such as Google trends are used. These can be anything from simple “How to buy Bitcoin” search queries, to “Bitcoin price manipulation” queries. Any rise in a specific search query can bring much needed insights about the broad sentiment and type of information that investors are looking at.

Recent values of Fear & Greed Index

Past couple of weeks have been rather chaotic. Since the Bitcoin broke the ATH on 10th of November at the price of 69,000 dollars, the biggest cryptocurrency has mostly been in decline. So much so, that not only did the biggest cryptocurrency lose more than 20 % of its value from the ATH, but the sentiment in the market changed drastically.

At the beginning of November, the sentiment was euphoric and people were not only expecting a new ATH, but many believed that 100,000 dollars for Bitcoin was about to happen by the end of the year. Only 4 weeks later, the overall atmosphere in the sector has completely changed and now people are much more worried about the beginning of the bear market than expecting the new top of the bull market.

Current Fear & Greed Index

Current Fear & Greed Index, Source: alternative.me

Interesting data points from the past

Being used for almost 4 years, the index has already flashed some interesting numbers. Looking back, these values make perfect sense with the situation that was going on in those times. Right now, we will look at some of the interesting events of the past few years that correspond to unusual values of the Fear & Greed Index.

26th June 2019: 95

The day was 26th of June 2019 and Bitcoin has just touched the 14,000 dollars mark. At that time the ATH was a bit below 20,000 dollars, but many believe that the run that Bitcoin made in those weeks was prone to create a new ATH. In less than 2 weeks, Bitcoin rose more than 87 % from 7,400 dollars to almost 14,000 dollars. The bulls were all over the place and anticipation of the new ATH and extreme market sentiment led to the Fear & Greed Index showing a staggering 95 – extreme greed.

This value was seen for the first time in the history of the index. It was even the first time that the index broke the level of 90. Extreme greed that was spreading around the markets, however, should have been a warning sign. In the coming 3 months, Bitcoin lost about 50 % of its value and as later investigation showed, the initial price increase was mostly attributed to one of the biggest crypto scams in history – Plus Token.

22nd August 2019: 5

In combination with the fears connected to the sudden price drop and alleged investigations connected to Plus Token, the atmosphere in the market changed drastically. So much so, that the Fear & Greed Index fell sharply down and showed a value of 5, for the first and so far, the only time. According to this index, there was never so much fear spreading around the cryptocurrency market than on 22nd of August of 2019, when Bitcoin price fell below 10,000 dollars.

In 2019, there were no entities such as MicroStrategy or El Salvador, which would be openly buying the “dips.” Thus, there were no big players that could turn the sentiment around. And since the information about the Plus Token scam has been appearing more on a daily basis, the overall mood was far from ideal.

13th of March 2020: 10

Probably the vast majority of our readers already know this date. 12th of March 2020 was the day when the World Health Organisation has officially claimed Covid-19 was a pandemic. All the markets saw huge drawdowns, cryptocurrencies included. Bitcoin lost almost 40 % on the day, with the lowest price of 4,410 dollars, the price we have not seen since.

However, the Fear & Greed Index flashed the value of 14 on the day, just to fall even more on 13th of March. For the coming week, the Fear & Greed Index was around or a bit below the value of 10, which was all caused due to the first wave of lockdowns, fears of Covid-19 and the uncertain future.

Whole history of Fear & Greed Index, Source: alternative.me

Long term perspective

While there have been few more occasions, when we have seen Bitcoin at similar values, it has never lasted so low for such a long time. Only a few days ago, we have seen similar values of about 16, which again, meant extreme fear in the markets. However, this time, the values of Fear & Greed Index were associated with the price of Bitcoin of around 42 000 dollars.

And that is another great benefit of this index. It can give anyone the ability to zoom out and see how the crypto market is progressing. If you told anyone a year ago that we would see prices of about 40 000 dollars and the sentiment in the market would be an extreme fear, no one would probably believe you. Thus, Fear & Greed Index can help with the overall perspective and can help to zoom out in times when people might be too fearful or too greedy.

Conclusion

While Fear & Greed Index is a reliable and commonly used indicator of market sentiment, just like any other indicator, it should not be used solely for investing and trading. This might be very tempting if one combines the values represented in the index, with one of the best known quotes of Warren Buffett:

“Be fearful when others are greedy. Be greedy when others are fearful.”

And while it might look like the past has proven this quote to be right, which might lead to buying when Fear & Greed Index shows extreme fear and selling when the index shows extreme greed, markets are more complicated than that. Nevertheless, it can help anyone with understanding the recent situation in the markets better, mostly by looking at the sentiment.