Fear and Greed Index: Why Does It Matter?
The crypto world is often driven by emotions. And nowhere is this more evident than in the prices of digital assets. When fear and greed take over, rationality goes out the window and price swings can be wild. Therefore, being aware of market mood is crucial to helping you choose whether to enter or quit a position.
This is where the Fear and Greed Index comes in.
Developed by alternative data provider Sentiment Metrics, the Fear and Greed Index is a gauge of how emotional or rational traders are at any given time. It does this by taking into account a range of factors, including volatility, social media activity, trading volume and changes in prices.
The index ranges from 0 to 100, with 0 being “extreme fear” and 100 being “extreme greed”. A reading of 50 is neutral.
Investors typically follow the Index based on the simple idea that crippling tends to reduce the value of bitcoin and excessive greed tends to drive up the price.
Extreme anxiety is thought to create selling pressure for bitcoin, which lowers the price and gives investors a chance to buy. On the other hand, excessive greed raises demand, raising the price and providing a favorable selling opportunity for bitcoin.
How is the index calculated?
The following variables make up the Fear and Greed Index for crypto:
Social Media
The best place to monitor Bitcoin and other cryptocurrencies is on social media. A robust community closely monitors the market and responds to it directly, especially on Twitter. The attitude can be reliably assessed by looking at specific hashtags and noting how many ones relating to Bitcoin occur throughout a specific time period. The level of greed increases as the number of requests and level of interest increases.
Social media encourages a variety of “pump and dump” tactics as well. Online posts, for instance, may provide purportedly useful information, encouraging purchases of a crypto asset. The information manipulators who released the information can sell their shares, dramatically cutting the price, once FOMO spreads and purchasers jump on the bandwagon, increasing the asset’s worth.
Volatility
Extreme price swings in the cryptocurrency market are a symptom of a somewhat uneasy market, whereas a consistent price trend indicates greater security. By measuring present volatility and comparing it to averages over the past 30 and 90 days, the Fear and Greed Index estimates future volatility. Therefore, very high volatility has a direct impact on price and may trigger a chain reaction.
Surveys
Surveys are a good way to directly ask participants in the cryptocurrency market and other interested parties how they are feeling. The surveys are carried out on a few reputable third-party websites with a respectable sample size and at regular intervals. As the chosen sample includes a group of cryptocurrency traders and investors, these surveys will assist us in estimating the general market sentiment.
This technique is frequently used in advertising efforts to enhance the perception of their goods. Votes are expressly bought, and the poll serves simply to improve marketing. Justin Sun, the creator of the cryptocurrency network TRON, has come under fire for utilizing this strategy to promote his establishment.
Market Momentum and Volume
The term “market momentum” describes the overall pace of acceleration of the market used to gauge market sentiment. Changes in trade volume might further support the upward or negative trend of the market momentum.
In other words, more traders are involved the higher the market volume. Using the averages of the previous 30 or 90 days, this component can be computed from the volume of the market at the moment. In a healthy market, the greed factor rises with the purchase volume.
Similarly, the put-call ratio can be used to estimate market volume. Divide the total number of put options (short positions) by the total number of call options to calculate the formula (long positions). If the final value is greater than 1, put options predominate and most players are making unfavorable assessments of the market (i.e., they expect prices to fall).
Google Trends
A particularly effective tool for examining users’ interests is Google Trends. This enables evaluation of Google search engine results pertaining to particular search phrases. For instance, search inquiries and prices rise in tandem as interest in Bitcoin grows. In the past, spikes in BTC Google searches have been accompanied by wildly fluctuating cryptocurrency values.
Bitcoin Dominance
The dominant cryptocurrency is Bitcoin. Its share of the overall market capitalization reflects its dominance. When Bitcoin has a significant market share, it may signal an unstable market as many investors switch their bets from hazardous altcoins to Bitcoin. In this scenario, Bitcoin is regarded as a haven, shielding investors from a precipitous price drop.
High amounts of investment in Bitcoin might also signify a safe market environment, therefore this characteristic can be read very differently
So why does the Fear and Greed Index matter?
The crypto Fear and Greed Index is a great way to determine when a local low point in cryptocurrency prices has developed and when a rally may take place. It can be a useful tool for predicting a shift in market mood and a subsequent decline in cryptocurrency values.
As it gets closer to the area of intense fear, the index has a tendency to reverse. At this point, anxiety transitions into the very beginning stages of greed before going full-blown.
Monitoring changes in market mood can be done with the use of the cryptocurrency Fear and Greed Index. Large swings may offer a chance to enter or exit the market before the rest of the market follows the trend.
Of course, the index is not perfect and should not be used as the sole basis for making investment decisions. But it can be a helpful tool for those looking to get a sense of market sentiment.
So, next time you’re feeling FOMO or FUD, take a step back and check the Fear and Greed Index. It just might help you make more rational decisions.
