What is Crypto Fear and Greed Index?

ResearchSep 14, 2022
What is Crypto Fear and Greed Index?

Market analysts use a gauge of crypto investor sentiment created by alternative.me. Like its counterpart for the stock market, the Crypto Fear and Greed Index reflects the behavior and interest of buyers and sellers based on two primary emotions. While the score is not suitable for forecasts on its own, it helps traders make short-term decisions.

What does the Fear and Greed Index look like?

This calculation uses a scale from 0 to 100 – extreme fear and extreme greed, respectively. It is based on two simple assumptions:

  • Greed indicates a growing market with increasing FOMO (fear of missing out) and projected correction.
  • Fear reflects the anxiety of most investors, and extreme fear may coincide with a buying opportunity.
Crypto Fear and Greed Index as of September 12, 2022.
Crypto Fear and Greed Index as of September 12, 2022.

Crypto fear and greed range

According to the developers' website, this tool could "save" crypto investors from their "own emotional overreactions". It covers a spectrum of market sentiment:

  • Extreme fear: 0–24.
  • Fear: 25–45.
  • Neutrality: 46–53.
  • Greed: 54–74.
  • Extreme greed: 75–100.
Fear/greed scale. Source; lookintobitcoin.com
Fear/greed scale. Source: lookintobitcoin.com

How do extreme fear and greed affect investment decisions?

Amid crypto market turmoil, many investors get swept up by their own emotions. According to behavioral economics, strong feelings may cause an irrational reaction, prompting us to pick options that work against our best interests. Here are the key things to know.

  • In a fearful market, participants sell hastily due to loss aversion. "The misery we get from losses is about twice as large as the happiness we get from gains," as Dan Ariely explains.
  • Inspired by uptrends, extremely greedy investors act out of FOMO, without sufficient research (DYOR).
  • Both market sentiments can cloud common sense, and they have historically been regarded as a reliable indicator of major change in stocks.
Crypto Fear and Greed Index dynamics since 2018. Source: Alternative.me
Crypto Fear and Greed Index dynamics since 2018. Source: Alternative.me

A score approaching 0 is a potential bearish signal but also a potential sign of buying opportunities — as more investors sell their assets, the latter plunge deeper. If the current index is close to the highest point in the green (100), the market is in a state of euphoria, with high hopes for further gains.

At BTC's all-time high on November 10, 2022 ($69,044.77), the index stood at 90. As of this writing (September 13, 2022), it is merely 34, while the coin is over 69% below its peak value.

Be aware of your biases

People tend to make impulsive decisions at the sight of green or red numbers, particularly as the crypto market is so volatile. The index data can help you monitor fear to leverage investment opportunities and spot potential indicators of impending declines.

Cognitive biases when investing in cryptocurrencies. Source: Patrick Oberstadt
Cognitive biases when investing in cryptocurrencies. Adapted from Patrick Oberstadt

However, pundits agree that this simple number is not reliable on its own, partly due to investors' cognitive biases. Loss aversion in a fearful market is part of a lengthy list of fallacies, among phenomena like:

  • Confirmation bias — the tendency to give most importance to data confirming a pre-existing conclusion or decision. It makes traders and investors likely to experience extreme greed and get blindsided when things go awry.
  • Social proof (Bandwagon effect) — the tendency to follow the crowd instead of conducting independent analysis. This bias underlies speculative bubbles fuelled by extreme greed.
  • Anchoring — overreliance on a certain past reference or piece of data. Trading history does not provide any clues as to the intrinsic value of a coin or token.

How is the Crypto Fear and Greed Index calculated?

Alternative.me’s Crypto Fear and Greed Index relies on five factors, from market momentum to social media. They have an uneven influence on the score based on perceived importance. The focus and weighting are skewed towards Bitcoin as opposed to other cryptocurrencies.

Market momentum and trading volume (25%).

This factor compares the current daily volume and momentum with 30- and 90-day averages. As the selling volumes expand along with negative daily movements, fear and the bearish pressure climb. The opposite scenario, when buyers forge ahead and positive movements become more frequent, indicates growing greed.

Current volatility of crypto market (25%)

Increased volatility dampens risk appetite, intensifies Bitcoin fear, and pulls the index down. Volatility and maximum drawdowns are also compared to their 30- and 90-day averages.

Google search volumes display shifts in the predominant sentiment. More searches potentially indicate a buildup of greedy market behavior, so they prop up the score. Searches for Bitcoin are key, and the terms are weighted by volume and perceived significance.

Some terms – for example, bitcoin crash or bitcoin price manipulation – may indicate Bitcoin fear and be unfavorable, so the weight is not equal. Generally, spikes of Bitcoin-specific searches have coincided with growing market volatility.

Example

As you can see from the chart below, crypto is dead saw an all-time high in search volume between May 8 and May 14, 2022. On May 8, the Bitcoin price plunged below $35,000 for the first time in 11 months. Over the same period, the Crypto Fear and Greed Index halved, collapsing from 18 to 9.

Google Trends dynamics for search term "crypto is dead" as of September 12, 2022.
Google Trends dynamics for search term "crypto is dead" as of September 12, 2022.

Crypto dominance (10%)

In theory, Bitcoin's growing dominance – expansion of its market cap relative to the market cap of all crypto – indicates fear. More investors turn to the coin as a "safe haven" amid market volatility. The share of altcoins is thought to rise in a greedy market, as participants invest in lesser-known assets pursuing big gains.

Criticism of the Bitcoin dominance factor

The current market dynamics call this component into question. Despite the crypto winter, BTC's market share is inferior to the percentage at its all-time high. As of this writing, it stands at 40.34%, as opposed to 43% in November 2021.

Apparently, BTC as a safe haven is now rivaled by ETH and stablecoins, whose value is pegged to fiat currencies or precious metals. Yet these alternative assets are not reflected in the Crypto Fear and Greed Index.

Social Media (15%)

Over 4.7 billion people — nearly 60% of the world's population — use social media, so it is only natural that it contributes to the index. Alternative.me uses a dedicated algorithm that sifts through Twitter hashtags related to crypto.

This analysis goes far beyond mention counting. It evaluates the frequency of posts and interactions over a particular time period. Declining interaction implies growing fear, while its upturns show increasingly greedy behavior.

Until recently, the score was influenced by insights from weekly crypto polls on strawpoll.com. They are still being conducted, but their inclusion in the calculation, which accounted for another 15%, has been paused.

Currently, Alternative.me is working on incorporating Reddit as a complementary source of social media insights. The Reddit sentiment analysis is likely to rely on a similar algorithm.

Using Crypto Fear and Greed Index

One simple number is not enough for sustainable strategizing. First, any persistent bull or bear market comprises multiple fear and greed phases by default. Most long-term investors experience the sentiment cycle shown in this diagram.

Investor sentiment cycle. Source: Zipmex.com
Investor sentiment cycle. Adapted from Zipmex.com

Secondly, the Fear and Greed Index has a weak correspondence to prolonged bull runs. Its accuracy is the highest for news and short-term changes. The latest fear and greed estimates are primarily a source of daily insights.

For example, a low score could imply room for growth, so you can buy, hold, or sell your chosen cryptocurrencies anticipating an uptrend. Rising prices typically provide selling opportunities, but a high index score could be a harbinger of a looming fall.

Problems with crypto fear and greed

The general sentiment helps in interpreting price rallies and local lows, but it is not always correlated with price movements. The Crypto Fear and Greed Index does not guarantee a chance to enter or exit faster than everyone else.

The index does not tell the future

When the score dives to extreme fear, it may reverse to show the first signs of greed. Alternatively, prices could plunge deeper and stay low for quite a while. By the same token, a market overwhelmed by greed may keep on rising.

The Fear and Greed Index is not suitable for predictions. As this chart shows, the market sentiment may diverge from the BTC price.

Crypto Fear and Greed Index dynamics vs. the BTC price. Source: lookintobitcoin.com
Crypto Fear and Greed Index dynamics vs. the BTC price. Source: lookintobitcoin.com

The index focuses on Bitcoin

Despite the rise of other large cryptocurrencies, the index shows an overemphasis on Bitcoin. ETH has the second largest market cap, so the ETH/BTC ratio merits consideration. Furthermore, the calculation ignores specific sectors showing rapid expansion, such as stablecoins and DeFi protocols.

Finally, the index disregards Bitcoin halving – a regular event with a deflationary impact on the price. Historically, it has been a bullish signal, but it could also turn bearish due to traders' anticipation. The significance of halving may be baked into the market in advance.

Key takeaways

Extreme fear and greed have similar effects on different markets, but one shouldn't trade or base long-term investment plans on one score. The Crypto Fear and Greed Index website, despite the publicity it gets, is merely a complement to an analytical arsenal. As a summary of social signals, current volume, momentum, and market trends, it reflects the sentiment but does not tell the future.

The data is still heavily skewed towards Bitcoin, although other coins and tokens may soon be included. Experts recommend combining the latest crypto fear and greed score with objective metrics, both fundamental and technical. The Crypto Fear and Greed Index provides daily clues, but its significance should not be exaggerated.

Disclaimer:

The information provided by CoinLoan (“we,” “us,” or “our”) in this text is for general informational purposes only. All investment and financial opinions expressed by CoinLoan in this text are from the personal research and open information sources and are intended as educational material. All outlined information is provided in good faith. However, we make no representation or warranty of any kind, express or implied, regarding the accuracy, adequacy, validity, reliability, availability, or completeness of any information in this text.

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