Market sentiment dominates the crypto space. Typically, greed leads to bullish trends, while fear results in bearish trends. Human psychology is predictably irrational, as many people react similarly in certain contexts. This is what sentiment analysis attempts to capture. It takes human psychology into account and analyzes the mood of the market.
Conclusions can be drawn and evaluated to forecast the course of the price action. An example of such behavior is the effect of FOMO (Fear of Missing Out), which occurs especially with strong price changes and tempts participants in the market to rash actions.
Similarly, technical analysis tools like traded volumes and historical data can be used to predict price movements.
If people behave the same way in certain contexts, is it possible to profit by simply being contrarian and behaving differently from others? This is where the crypto Fear and Greed Index is helpful.
What Is the Fear and Greed Index?
The Fear and Greed Index was developed by CNN Business for the stock market. It is an analytical indicator that evaluates market sentiment. Various factors come into play which is weighted differently. In sum, you get a number between 0 (fear) and 100 (greed), where 50 is considered neutral.
To obtain a meaningful result, the quality of the data is crucial. Thus, even small errors can greatly flaw the analysis, invalidating it. As a result, faulty decisions and placements in the market can cost a lot of money.
Uncertainty in the crypto market could be utilized as a potential opportunity. Often, maximal fear in the market implies the arrival of a bearish trend. This could be an ideal time to buy the dip and therefore be considered a buying opportunity for investors. Likewise, extreme greed in the market could be interpreted as an end of the predominant bullish market. Therefore, selling at that point before the market goes south is a good idea.
The fundamental in sentiment analysis is the behavior of the largest crypto exchanges on the market. Often, big price changes happen there first, and other participants in the market orient themselves to them. For example, analyzing order books is an indicator that is difficult to reproduce in an index but can have a major impact on the behavior of traders. The Bybit exchange displays its order books in real-time, whereby price changes in small time windows can often be weighed against the number of buy and sell orders.
How Does the Fear and Greed Index Work in Crypto?
Theoretically, you can design your own Fear and Greed Index. The prerequisite for this is that the data used is both correct and correctly used. For example, a certain basic knowledge of market events and reactions should be available to assess the effects of certain events realistically. The weighting of the individual factors also plays an important role in the analysis.
Different zones on the index chart and slider have different meanings.
This is how the Fear & Greed Index is measured:
- 0–24 = Extreme Fear
- 25–49 = Fear
- 50–74 = Greed
- 75–100 = Extreme Greed
In the index chart, fear (a score of 0 to 49) symbolizes the undervaluation of the crypto asset. Greed (a score of 50 to 100) implies an overvaluation of cryptocurrencies and a potential crypto bubble. Every 8 hours from 00:00, 08:00, and 16:00 UTC, the crypto Fear and Greed Index is refreshed. To determine its value, we assemble data from six distinct references.
How Is the Index Measured?
The rating of the Fear and Greed Index for Bitcoin is composed of the following factors:
Extreme fluctuations in the crypto prices are signs of a rather anxious market, while a stable price development means more security. The Fear and Greed Index measures current volatility and compares it to the averages of the last 30 and 90 days, respectively. Unusual and strong volatility, therefore, directly affects the price, potentially leading to chain reactions.
Market Momentum and Volume (25%)
Market momentum refers to the aggregate rate of acceleration of the market to measure the market sentiment. The market momentum can go in an upward or downward trend, which can be further be confirmed by changes in trading volume.
That means the greater the market volume, the more traders who are participating. This factor can be calculated from the current market volume using the averages of the last 30 or 90 days. The higher the purchase volume in a positive market, the higher the greed factor.
Likewise, the market volume can be valued by the put-call ratio. The formula is calculated by dividing the total number of put options (short positions) by the total number of call options (long positions). If the resulting value is higher than 1, the put options predominate, and the majority of participants are evaluating the market according to negative sentiment (i.e., they expect prices to fall).
Social Media (15%)
Social media is a good meeting place for exchanges on Bitcoin and cryptocurrencies. Especially on Twitter, a strong community continuously observes the market and reacts directly to it. By evaluating certain hashtags and noting how many related to Bitcoin occur in a certain period, the mood can be analyzed quite accurately. The more the requests and the greater the interest, the higher the greed factor.
There are also numerous forms of “pump and dump” encouraged by social media. For instance, online posts may give supposedly valuable information, spurring purchases of a crypto asset. Once FOMO spreads and buyers hop on the bandwagon, raising the asset’s value, the manipulators who posted the information can sell their shares, significantly lowering the price. Then, they can buy back their cryptos for profit.
Surveys are suitable for directly querying the mood of Crypto market participants along with other interested parties. A few third-party credible websites are used to conduct the surveys at regular intervals with decent sample size. These surveys will help us estimate the overall market sentiment as the selected sample represents a group of crypto traders and investors.
Advertising campaigns often use this method to present their product in a better light. Votes are specifically purchased, and the survey only serves better marketing. The founder of the cryptocurrency platform TRON, Justin Sun, has been criticized for using this method to advertise his platform.
Bitcoin Dominance (10%)
In the crypto market, Bitcoin is King. Its dominance is reflected in its share of the total The market capitalization (or market cap) of a cryptocurrency is a measurement of its market value. In other words, it.... A large dominance of Bitcoin can stand for an uncertain market, as many investors shift their investments from risky altcoins to Bitcoin. In this case, Bitcoin is considered a haven, protecting investors from a sharp fall in prices.
However, this factor can be interpreted very differently, as high levels of investment in Bitcoin can also represent a secure market environment.
Google Trends (10%)
Google Trends is a very powerful tool for analyzing users’ interests. This makes it possible to evaluate entries in the Google search engine related to specific search terms. For example, as soon as interest in Bitcoin increases, search queries and prices increase concurrently. Historically, increases in BTC Google searches have coincided with dramatic volatility in crypto prices.
What Does Extreme Fear and Greed Tell You?
Extreme fear levels in the index have always preceded bullish reversals of crypto prices. At this level, the index shows that prices are very low, as most traders and investors are disposing of their crypto holdings, pushing prices further down. For savvy traders, this is usually the optimal point to buy into the market. The index accurately predicts reversals of crypto price performance. Every time it’s reached an almost extreme level of anxiety, it has often predicted a reversal of crypto prices.
Similarly, extreme greed, usually driven by FOMO, means that market prices are often in the overbought zone. This indicates a growing risk of the bubble bursting, with a minimal reward for staying in the market. It is often a signal to short the market or sell one’s crypto holdings. Typically, extreme greed precedes a bearish trend.
These findings seem to confirm that extreme market sentiment is an accurate predictor of a turnaround in crypto prices. Extreme fear in crypto markets has historically morphed into bullish trends, while extreme greed has turned into bearish trends.
Can You Use the Crypto Fear and Greed Index to Predict the Market?
The crypto Fear and Greed Index is an excellent indicator for predicting when a local low point in crypto prices has formed and when a rally could occur. In the right hands, it is a valuable tool for timing a change in market sentiment and a subsequent reversal in crypto prices.
The index tends to reverse as it approaches the territory of extreme fear. This is the moment when fear turns into very early signs of greed before entering into full-blown greed territory.
The crypto Fear and Greed Index can be a helpful tool for monitoring market sentiment turns. Large fluctuations may present an opportunity to enter or exit before the rest of the market mirrors the trend.
The index doesn’t work as well for long-term analysis of crypto market periods. Within a long-term bull or bear run, there are recurring rounds of fear and greed. These switches are valuable for swing traders.
The Bottom Line
Although the crypto Fear and Greed Index can be a very important and helpful tool in analyzing cryptocurrencies, it should never stand alone. Several factors always play a role in pricing and should be considered.
For example, the Fear and Greed Index refers only to sentiment analysis, while technical analysis and Fundamental analysis is an approach used by cryptocurrency investors to establish the intrinsic value of a crypto asset.... work independently of market participants’ emotions. However, keep in mind that some new financial or geopolitical events may void any analysis. All the best!