Crypto Fear and Greed Index, explained
A gauge for crypto market sentiment ⚙️
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The Crypto Fear and Greed Index is a tool that indicates the emotional state of crypto market participants.
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By aggregating various data points relating to sentiment, it offers a simple numerical score ranging from 0 (extreme fear) to 100 (extreme greed).
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Some crypto traders may use this index to identify potential market reversals, particuarly when sentiment shifts toward the extreme ends of the scale.
In a 1986 letter to Berkshire Hathaway shareholders, Warren Buffet famously wrote: “...we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
Therein lies the rationale behind the index — to try to identify opportunities where the market may be overbought or oversold, as indicated by investors’ greed and fear.
Here’s how to read the index:
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When the index reads between 0-24, that indicates extreme fear. If the market is overwhelmingly bearish, this suggests that there aren’t that many people left to sell, and could represent a buying opportunity.
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When the index reads between 76-100, that indicates extreme greed. When most investors are greedy and have the fear of missing out (FOMO), then buyers may be in short supply, and that might indicate a reversal to the downside.
Simply put, if everyone has the same directional bias about the market, then perhaps the current trend has reached its climax.
NB: It may not be wise to use the index in insolation to make investment decisions. Consider combining it with various factors to generate a more informed thesis about the market’s next potential move.
How is the Crypto Fear and Greed Index calculated? 🧮
The Crypto Fear and Greed Index is calculated by aggregating various data points that reflect market sentiment and crypto-related activities. The index is created by alternative.me and uses the following inputs:
Volatility (25%)
This measures recent market volatility and maximum drawdowns relative to average values over the last 30 to 90 days, arguing that an “...unusual rise in volatility is a sign of a fearful market.”
Market Momentum/Volume (25%)
This component compares the current trading volume and momentum again to 30 and 90 day averages. Higher volumes in a bullish market indicate that the market is greedy.
Social Media Sentiment (15%)
Here, the developers examine what is being said on X (formerly Twitter), analyzing the number of posts made about Bitcoin (BTC) and their hashtags. They also examine how fast and how much engagement these posts get, theorizing that an unusually high interaction rate corresponds with “...greedy market behavior”.
Surveys (15%)
At the time of writing, this input is currently paused. Previously, weekly crypto polls surveyed investors' perceptions of the market, with as many as 3,000 respondents.
Dominance (10%)
This tracks Bitcoin’s dominance in terms of market capitalization, compared to altcoins. The developers posit that a rise in Bitcoin dominance is caused by fear, reflected by investors’ diminished appetite for riskier cryptocurrencies. Conversely, when Bictoin dominance declines, this implies that investors are adopting a more “risk-on” approach to the market, with greed driving their desire for outsized gains.
Google Trends (10%)
By tracking various Bitcoin related search queries — and especially the changes in search volumes — it’s possible to get a sense of how investors are feeling.
You can examine Google search trends yourself. For example, the volume for the search term ‘how to buy bitcoin’ peaked in 2017 and has been slowly trending down ever since.
Each of the above inputs are combined to produce the index’s daily score, which is updated on a daily basis.
Why the Crypto Fear and Greed Index matters for investors 🤔
Broadly speaking, sentimental analysis is one of four sources of information that crypto investors can use to make investment decisions, with the other three being:
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Technicals: analysis of historical price action, patterns and indicators.
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Fundamentals: analysis of financial, economic, and qualitative factors.
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On-chain: analysis of transaction data, wallet activity, exchange flows etc.
Investors in financial markets tend to have a herd mentality. Therefore, if you know how the herd is thinking and how it is positioned, you may be able to gain an edge over the majority. Sentimental analysis taps into the collective psyche of the herd, offering investors some useful insights:
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Timing: knowing when the market is reaching extreme fear can help investors time their entries. In his interview with Chat With Traders, veteran trader Jason Shapiro talks about how he uses the Commitments of Traders report (which tracks how investors are positioned in traditional markets) to be a contrarian. As indicated by the interview, the extreme imbalance of markets can lead to reversals, and the Crypto Fear and Greed Index is no exception, as detailed below.
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Confluence: perhaps you have a working thesis that a market is about to reverse. The technicals and fundamentals are in alignment, and after analyzing the sentiment, the data is confluent with your idea. This is extremely useful as an investor, as the more evidence you have to support your thesis, the more confidence you can have.
Interpreting the Crypto Fear and Greed Index 🧐
The index must be taken in context and with reference to other variables. Extreme fear may mean that Bitcoin is oversold, but it does not mean that an investor must buy.
Investors have to examine why the market is fearful/greedy and investigate the significance of those emotions. The following are a few questions you might ask:
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Is the market overreacting? Is this fear/greed warranted?
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If the market is fearful/greedy because of news, does that news represent an existential threat to Bitcoin as an asset?
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Does the index figure coincide with some significant technical data, such as a major historical support/resistance level?
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Has the market been fearful/greedy for a prolonged period which has now climaxed to extreme levels?
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Is the market disregarding important fundamental factors?
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Does the index coincide with signals on crypto futures indicators?
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If the market is fearful, how does it react to negative news?
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If the market is greedy, how does it react to positive news?
What does Extreme/Greed Fear indicate? 👨💻
Extreme fear means that investors are worried about lower prices. Extreme greed means that investors are excited about higher prices.
If we develop that further, it’s clear to see why these extremes can be irrational.
If the price of Bitcoin (BTC) has been downtrending for months, and has a significant capitulation to lower prices that coincides with extreme fear, then it’s a very real possibility that the market is oversold.
Is it logical that investors are fearful simply because of the bearish price action? Or is the market now much more likely to reverse?
Thought experiment
If we look at a couple of cherry-picked examples of extreme fear/greed in Bitcoin, we can see that they did coincide with major reversals.
Examine these examples and decide for yourself the significance of the index in the context of the situation. This exercise might help you determine the utility of the index the next time it reaches extreme levels (for a better visual experience of the index, visit Glassnode):
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On 26th June 2019, after an exuberant run to ~$14.000, Bitcoin reached 95 on the Fear and Greed Index — the highest recording since records began in February 2018. June happened to be the top for Bitcoin in 2019. In fact, it did not trade at $14.000 again until November 2020. If you look at a price chart, is there anything significant about that price level? Are there any indicators that signaled a possible reversal at that time in June 2019? What did the weekly candle look like when Bitcoin topped?
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On March 14th, 2020 during the “covid crash,” Bitcoin reached 8 on the Fear and Greed Index - it had only recorded a lower score on one occasion in 2019. The exact bottom in terms of price occurred the day before on the 13th March. That low of around $4.000 turned out to be the lowest Bitcoin would trade for over four years. Was the market’s reaction to the Coronavirus warranted, or was it purely borne out of fear? What drove the market to have such a large crash — was it the wider panic (and the market shifting violently to “risk-off”) or was it a reflection of Bitcoin as an asset? Was there anything significant about the price that Bitcoin found support at?
How to use the Crypto Fear and Greed Index for trading 💻
It makes sense here to start by saying that using the index in isolation would likely lead to a loss of capital. As with many technical indicators, it is a useful data point that can be used as part of a wider thesis, but without context it can be misleading.
The following are some guidelines on how you can incorporate the index into your analysis:
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Look for the stars to align. Examine historical examples where the index reached extreme levels and what coincided with it, with respect to technicals, fundamentals and perhaps on chain analytics. For example, does the index have a significant positive correlation with another technical indicator?
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Look for anomalies: were there occasions when the index spiked in either direction but price didn’t follow? What happened after? Did it lead to a bigger move? Does the index ever diverge from price?
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Understand how the index is flawed: don’t incorporate anything into your analysis unless you know how it works. Examine how the fear/greed figure is calculated and then consider what might be missing. Are there any data points you could add to improve it?
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Consider what strategies it would complement: Think about how you could use the index in your own trading with respect to entering and exiting positions. Could you set an alert when it reaches extreme levels to start dollar cost averaging? How does that strategy perform historically if you backtest it?
Example of Crypto Fear and Greed Index in action 📊
Let’s imagine a scenario where an investor might use the Fear and Greed Index to help them decide when to buy Bitcoin.
Bitcoin has been trending down for several weeks. Volume has been increasing as it descends, and on the back of some bearish news about the US economy, it has a sharp spike downwards.
Over the following week, the Fear and Greed Index reaches extreme fear, with a value of 8. An investor uses this as an opportunity to look at whether now might be a good time to enter a position. By looking at several data points — not just the Index — the investor notes a constellation of factors that all point to a potential reversal:
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The last time the Fear and Greed Index reached this level, it marked a local bottom.
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The weekly RSI has a bullish divergence.
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The news doesn’t really relate to Bitcoin fundamentally, rather, it’s a reflection of a more general panic about other factors.
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Volume climaxed after the day news broke, preceding a noteworthy bullish pin bar candle.
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Backtesting similar scenarios indicated that dollar cost averaging for the next month was a successful strategy.
Several months later, after an initially sluggish recovery and consolidation, Bitcoin entered a mini bull market. The trader waits for the index to reach extreme greed, before dollar cost averaging out of the position.
In summary, the Crypto Fear and Greed Index is a useful tool for gauging sentiment in cryptocurrency markets, combining many carefully considered and meaningful inputs. Combined properly with other important contextual factors, it can help investors make more informed decisions based on the emotional state of the market.
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Disclaimer
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