Fear and Greed in Crypto Markets
The crypto market is primarily driven by investor sentiment. If they have pessimistic forecasts about asset prices, then they will most likely decide to sell and, thus, actually lower the price, as they might be concerned that their current holdings might lose their value. If, on the other hand, they are optimistic about the future price movements of cryptocurrencies, then they would most likely invest their money to buy additional assets as they would want not to miss a potential market pump. The additional acquisition of assets can then create a flow of money into the market and thus increase prices. These are the two sentiments that are also known as fear and greed and are key to many of the people who observe the price movements of cryptocurrencies.
What Is a Fear & Greed Index?
Fear is typically linked to declining markets or asset values, whether those declines are brought on by macroeconomic factors (like inflation, recession, or geopolitical factors) or other factors (like declining values of certain assets like an oil and gas price decline). On the other hand, greed is associated with an upside movement in the markets. However, there is another type of fear associated with this situation which is called FOMO (fear of missing out). The indicator was originally developed by CNN Money to measure how these two human emotions impacted the prices of the assets on the stock market. The index’s goal was to measure whether certain markets or assets were trading above their expected value due to greed, or below their purported value due to investors being afraid of potential downfall or optimistic about a potential upside movement. The spectrum of this indicator ranges from extreme fear (common for market crashes) to extreme greed (common for all-time highs and other upside movements).
How Is the Traditional Fear & Greed Index Calculated?
The first version of the index is calculated from several factors that included stock price momentum, stock price strengths, trading volumes, put and call options, junk bond demand, market volatility (based on a 50-day moving average), and safe haven demand. However, these factors are only applicable to the stock market which means that they are not applicable to the movement of the prices of cryptocurrencies which prompted the creation of a separate Index which is specifically attributed to crypto.
How Is a Crypto Fear & Greed Index Calculated?
There are multiple indexes of this type that rely on different factors for their calculations. The most common data sources for the calculation of this indicator include:
- Volatility – high levels of volatility indicate that the market is volatile and investors are uncertain, which means pessimistic expectations. Low volatility means stability and increasing optimism, which most certainly means that prices are increasing;
- Market Momentum – this indicator gauges the market’s general trend while taking trade volume and price movements into account. A market in an uptrend typically represents optimism, whereas a market in a decline typically represents pessimism;
- Sentiment on social networks – this factor indicates what are the opinions and sentiments of crypto investors on social networks, as well as what are the news and analyses regarding the current situation in the sphere. If most investors are pessimistic, then the fear index will prevail, while with more positive sentiment, greed will prevail;
- Volume – high levels of volume mean that investors tend to buy more assets and accordingly push the price of cryptocurrencies up, which means more greed. Low levels of volume are associated with pessimism and reluctance to acquire additional assets, which is associated with an increase in the fear index
How Do You Read & Trade with the Crypto Fear & Greed Index?
The index can help you when taking trades, but it is not necessarily the only indicator you can use. This trading tool can show you the current sentiment of the market as well as the sentiment of the past weeks. Through this information, you can determine what the current trend is and how long the market has been moving in a certain direction. However, the data that it provides you might not necessarily mean that you will be able to predict the next movement. The sentiment might for example be “extreme fear”, but that does not necessarily mean that the market is currently at the bottom.