What Is a Crypto Fear and Greed Index?
Emotions come in different forms in all living creatures. As humans, we are very familiar with the emotions of fear and greed. We consider a lot of factors during decision-making and in our psychology because of the properties of complexity and diversity that they possess. The effect of fear and greed on the collective decision-making process and how the significance of the influence of these emotions on the crypto market is measured using the Fear and Greed Index are discussed in this article.
Fear and Greed in Crypto Markets
Misleading information or damaging propaganda about a particular cryptocurrency asset, project, or platform is referred to as FUD which is a crypto slang for ‘fear, uncertainty, and doubt’. Such type of information appeals to fear which is one of the basic human emotions.
Sometimes users misunderstand and attribute causes that are inaccurate to some negative information such as market corrections, thereby unintentionally experiencing FUD. Users interpreting a crypto market correction that follows a general decline in the economy as “crypto is dead” is a typical example. FUD usually spreads very quickly, which can cause a lot of damage when affecting individual projects due to the arrival of online communities.
Some individuals or corporations, such as top-dog investors and competitors of a project, who are better placed to make gains from intentionally orchestrating FUD may do so, thereby manipulating the markets. The fact that this act carries serious legal repercussions in many jurisdictions is noteworthy.
What Is a Fear & Greed Index?
We first need to understand how the markets are affected by fear and greed.
Market participants tend to be frightened by losing their capital when fear is the dominant emotion. They may start selling their assets due to their concerns about the value of their token holdings and the stability of the market. This can also drive some traders to try to make gains from the feeling of fear by short selling these assets.
A decline in assets values or in the market, which is either caused by macroeconomic factors such as inflation, economic crisis, recession, or geopolitical factors; asset-specific factors such as the decline in the values of certain assets; or a tumble in the token price of a crypto project caused by negative information, is usually attributed to fear.
Market participants try not to pass on the possible gains they would be able to make when greed is dominant. They do this by trying to amass more assets, which usually occurs during an uptrend in the markets. The “fear of missing out” (FOMO) is a type of fear that usually accompanies greed. In this case, instead of being afraid of incurring losses, market participants are afraid of passing on the potential gains they would have made.
The Fear & Greed Index
CNN Money developed the original Fear and Greed Index as a key market indicator which measures the effect of the human emotions of fear and greed on the stock market. The measurement of markets or assets that trade above their normally assumed value due to greed or below their normally assumed value due to fear was the index’s goal.
The spectrum that represents the Fear and Greed Index ranges from extreme fear at one end to extreme greed at the other.
Several factors were used by the CNN Fear and Greed Index to measure the presence and amount of fear and greed in the stock markets. However, due to the fact that the cryptocurrency markets are different in many ways, some of these factors cannot be applied to them. This therefore made the development of a cryptocurrency-specific Fear and Greed Index necessary.
How Is the Traditional Fear & Greed Index Calculated?
Factors relevant to stock markets were relied on during the development of the CNN Fear and Greed Index. These factors include:
- Stock price momentum – which is gotten when the index is compared against a 125-day moving average.
- Stock price strength – which is gotten by comparing the number of stocks whose prices are on a 1-year all-time high against the number of stocks whose prices are on a 1-year all-time low.
- Trading volumes – comparing the trading volumes of rising stocks against the trading volumes of declining stocks.
- Put and call options – a higher number of put options signifies fear; a higher number of call options signifies greed.
- Junk bond demand – greed is usually signalled by a higher demand for bonds with increased default risk.
- Market volatility – which is usually calculated based on a 50-day moving average.
- Safe haven demand – which is calculated based on the difference between the yields of stocks and the yields of treasuries like sovereign bonds.
Most of these factors, as you can see, cannot be applied directly to the cryptocurrency markets.
How Is a Crypto Fear & Greed Index Calculated?
The fact that factors that affect the stock markets were not directly applicable to the cryptocurrency markets led to the development of several cryptocurrency indexes like the one developed by Alternative.me which makes use of weighted data sources that include:
- Volatility (25%) – The volatility and the average values of the current market are compared to the volatility and average values of the last 30 and 90 days. An increase in volatility signals an increase in fear.
- Market momentum/volume (25%) – Current buy and sell volumes are compared to that of those last 39 and 90 days. An increase in the buy volume signals greed, while an increase in the sell volume signals fear.
- Social media (15%) – This is gotten by finding the volume of social media interactions, interest, and general thoughts towards Bitcoin.
- Surveys (15%) – This is gotten by finding the opinions of investors and users using polls.
- Dominance (10%) – A rise in the dominance of Bitcoin signifies fear.
- Trends (10%) – Gotten from the rate at which a cryptocurrency is searched for on Google.
How Do You Read a Crypto Fear & Greed Index?
The lowest end of the Fear and Greed Index spectrum has the highest fear value, while the highest end of the spectrum has the highest greed value, with an array of likely values between them.
Calculations and data sources showing current and historical values are the basis of the Index.
The Index provides a corresponding interpretation for every numerical value shown. For instance, it would show “10 – Extreme Fear” or “65 – High Greed”.
Using the Fear & Greed Index
The Fear and Greed Index should not be considered as a single determinant for cryptocurrency investors when they are trying to make decisions. It should instead be considered as one of the many indicators which are to be utilized.
An index should be used to measure the current market sentiment and the direction of its trend by reading its current and historical values.
For instance, an increase in the fear sentiment over recent weeks shown by the index (for example; changes from “48 – Fear” in the past month to “30 – High Fear” in the past week to “23 – Extreme Fear” currently) indicates that, according to the index, the trend has been moving towards more fear because the general sentiment is fearful.
This shows that the market is in a downward direction owing to more and more market participants disposing of their assets thereby making it possible for certain assets, to trade below their normally assumed value.
Alternatively, markets with a (bullish) upwards direction and an index showing extreme greed with a trend increasing to greedier over the past weeks, indicate greed as the dominator and show the possibility of certain assets being traded above their normally assumed value.
It is noteworthy to understand that these indicators do not completely show the performance of future markets because they only reflect the sentiments of some market participants. The “herd mentality” of not paying attention to other key indicators while following market sentiments should be critically avoided. The signal of a possible turnaround in market conditions by extreme greed or extreme fear may pose a disadvantage to market participants who do not note the signs.
Due Diligence and Do Your Own Research
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