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Does the Fear and Greed Index improve crypto trading?

fear and greed indesx visual. One man looking scared and another looking greedy holding a bitcoin
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The Fear and Greed Index was developed by CNN Money, a business, financial, and personal finance news website which is part of CNN Business in 2012 to measure the stock market's performance.

Originally, the index was measured using seven data points: safe-haven demand, market volatility, junk bond demand, put and call options, stock price breadth, stock price strength, and market momentum.

From a study published in May 2023 titled The Relationship between CNN Money’s US Stock Market Fear and Greed Index and US Stock Indices, the authors concluded that five stock indices which included Dow Jones Composite, New York Stock Exchange (NYSE) Composite, S&P 500, and NASDAQ showed a positive relationship at the Greed level. 

This means that many potential investors have the right technical indicators in their favour should they wish to add more stock to their investment portfolios. 

Since the financial market downturn in March 2020, when the coronavirus pandemic (COVID-19) led to a global lockdown that negatively impacted centralized and decentralized investment assets, the index has become more relevant in the crypto space.

While many crypto traders continue to monitor the tool, few have an extensive understanding of what it represents and how it could influence their trading patterns positively. 

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The Fear and Greed Index and crypto

The index uses market trends and social signals to determine the general sentiment of the entire decentralized finance market with Bitcoin (BTC) and other large-cap assets (those with more than $10 billion as market value) as the primary focus on measurement. 

Like the tool developed by CNN for the stock market, this is also an index because it sources data from multiple sources and analyzes them into a single figure. 

The crypto fear and greed index has been dissected into four categories:

  • EXTREME FEAR comes in orange and is rated from 0 to 24.

  • FEAR is represented by amber and yellow and rated from 25 to 49).

  • GREED is shown in light green and can be found from 50 to 74.

  • EXTREME GREED is graded from 75 to 100.

FEAR normally shows signs of bearishness, while GREED indicates signs of bullishness.

Crypto Fear and Greed Index: How is it calculated?

While the index for the stock market is derived from seven data points, crypto is weighed using five key signals: search engine trends, dominance, social media, volatility, and market momentum/volume.

For simplicity and educational purposes, we are going to settle on the largest digital asset by market capitalization BTC in explaining and understanding the five signals. 

Search Engine Trends: Bitcoin is the most popular cryptocurrency across the globe.

Data is sourced from search engines such as Google, Yahoo, Bing, and others to use trends as an indicator for the index.

A good example can be attributed to Google Trends, where the most searched terms are stored for a given period.

With BTC, it is not uncommon to come across searches for terms such as Bitcoin Price Prediction, Is Bitcoin a Good Investment in 2023, How High Will BTC Go In 2023, Will Bitcoin Hit $100,000 in 2023, and Bitcoin Price Manipulation. 

While the first four are signs of bullishness, the search by millions on whether the value of BTC is being manipulated is a fearful signal, which is taken into account in deriving a single figure for the overall sentiment around the flagship digital currency.

Market Momentum/Volume: As one of the vital factors in technical analysis, the volume shows the total liquidity being poured into a particular cryptocurrency.

Take BTC, for instance, which was exchanging hands for around $27,000 in May 2023. The minimum daily volume was $7 billion, while the maximum daily volume hovered around $20 billion.

Within the same period in 2022, BTC traded for about $30,000 and the lowest and biggest daily trading volumes were $17 and $70 billion, respectively.

In May 2021, BTC was trading above $50,000 and within the fifth month of the greatest year in the trading history of cryptocurrencies, daily trading volume reached a peak of $126 billion. 

From the statistics presented, it is clear that volume has gone down in 2023, and this exhibits signs of fear on the part of many traders to risk their hard-earned money on the first blockchain-backed digital asset. 

Social Media: This has become a powerful tool for measuring greed and fear among investors. If the hashtag (Bitcoin, BTC, bitcoin, or btc) trends on social media platforms like Twitter, it means there is growing interest in buying the coin.

If the same momentum is not felt across the platforms, sentiment for the crypto asset has diminished, reflecting in relatively lower trading volumes. 

Volatility: According to Oxford Dictionary, volatility is where something is liable to rapid and unpredictable changes, especially with adverse effects. Crypto is highly volatile, and the rapid fluctuations in the value of BTC and other cryptocurrencies are normally seen as FEAR (bearishness) for most market participants.

Dominance: Bitcoin dominates the crypto market. As of 11:00 UTC on 2 June, 2023, it commanded 45.9% of the industry's total market cap and was followed in second place by ETH with 19.9%. 

Within the same period, the index was at 50 (Neutral) because BTC does not have a huge hand in the market (it has less than 50% of the overall market).

Should things change for BTC to command more than half of the sector’s value, the index will fall into FEAR since many traders will be moving all their assets into what is deemed a safer asset. 

On the other hand, if BTC loses its dominance further and other assets rise, the index turns into GREED since traders are turning into speculative assets (more altcoins).

Does the Fear and Greed Index improve crypto trading?

The index has played an integral role in the trading patterns of many traders. This will continue, especially in times when numerous centralized financial bodies have started introducing regulations for the crypto economy.

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Author: Raphael Minter

Raphael Minter/ Albert Zuhnden (preferred pen name) is a crypto finance writer, data miner, and fundamental analyst. Raphael has written hundreds of articles about centralized and decentralized financial instruments such as precious metals, commodities, stocks, and cryptocurrencies. He broke into digital finance in 2016 and believes digital assets and blockchain technology is the future of finance.

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