Fear and Greed Crypto Index: Is It Effective?

The crypto fear and greed index uses social signals and trends to score the overall sentiment of the cryptocurrency market.

Like all indexes, the fear and greed index crypto style builds its rating from various data sources to provide a single figure between 1 and 100. This metric is a popular tool in the arsenal used by cryptocurrency traders and investors looking to determine whether it is a good time to make their moves in the market.

The index provides four categories depending on the score. These are:

• 0-24 Extreme Fear (orange)

• 25-49 Fear (amber/yellow)

• 50-74 Greed (light green)

• 75-100 Extreme Greed (green)

As anyone who has invested or attempted to trade crypto will know, cryptocurrency is often subject to high levels of volatility. Emotions can get the better of investors. People often rush in to trade for fear of missing out (FOMO), getting greedy when prices ascend or panic selling when prices drop.

Managing emotions is key to becoming a successful trader. The fear and greed index crypto assessment can be a helpful tool to accomplish that.

By analysing available information, traders can remove emotion and make smarter decisions. When conditions are categorised as 'Extreme Fear', it is often a good time to buy. Conversely, when the indicator shows 'Extreme Greed', it is often a good time to sell. The indicator is easy to find through a simple Google search or by accessing its Twitter feed.

Final score

The index is calculated and managed by Alternative.me and uses a range of sources to determine its score. Volatility, market momentum/volume, social media sentiment, market dominance, and trends are all used to help determine the final score.

• Volatility – the rate of change between buy and sell pressure. A rise in the volatility rate usually signals the start of fear in the market.

• Market momentum/volume – market momentum is used in conjunction with the rate of current volume. If volume begins to outpace the current momentum, then the market is becoming too greedy.

• Social media sentiment – by using a tool like the Twitter Sentiment Analysis Tool, high interaction rates can be identified, and greedy behaviour can be avoided.

• Market dominance – when Bitcoin dominance starts to rise, it is generally accepted that this signals that wise money is moving to the safer haven of the number one cryptocurrency. Conversely, when Bitcoin dominance begins to fall, this is seen as a good time to move your capital into more risk-on altcoins.

• Trends – the fear and greed index crypto assessment uses data from Google Trends to calculate how many people are searching for cryptocurrency information. Terms such as 'Is Bitcoin a scam?' are viewed as bearish indicators, whereas 'What will the price of Bitcoin be in 2030?' are considered bullish.

Effectiveness

The chart below shows how accurate and effective the fear and greed index crypto assessment can be.

As you can see, the index lives most of its time in the greed area and rarely drops into fear for more than a month. It also demonstrates how crypto sentiment closely correlates with the macroeconomic situation.

The lowest level sentiment fell to was immediately after the first Covid impact in March 2020 as worldwide financial markets sold off to protect their investments. Little more than a year later, we saw the index reach its highest point in February 2021 and the beginning of the DeFi summer.

This chart shows that although situations can change overnight, when the indicator shows greed or extreme greed, it tends to stay in that area for extended periods. Overall, I believe this chart shows that the general sentiment for crypto has been pretty healthy for the past two years.

However, many investors view the fear and greed index as only a short-term indicator rather than a long-term analysis forecast. This is mainly due to its reliance on news events and short-term fluctuations. This probably explains why the tool is more popular among traders than long-term investors.

Emotions

As mentioned above, anyone involved with crypto trading or investing will understand how volatile the market can be. Unless we are careful, we may become exposed to the dreaded emotional roller-coaster.

Not much imagination is required to understand that this is not the best place to be. So, one of the more common questions people ask me is, how do we control our emotions when trading?

The advice I will share is to always consider and reconsider before making any market moves. When you think that the average price prediction for Bitcoin by 2030 is $500,000, it becomes clear that this market still has plenty of room for upward movement.

Therefore, I think long and slow moves are best, if any at all. However, here are some of the best ways I find to remove the emotion from your financial decision-making:

Diversify – a diversified portfolio is often the best way to deal with the peaks and troughs of long-term investing, and it is no different with cryptocurrency.

Dollar Cost Averaging (DCA) – dollar cost averaging will remove much of the strain associated with trying to time market tops and bottoms. This is one of the most powerful ways to remove emotion from the game. Just set up a recurring payment and focus on the long term.

Be fearful when others are greedy – according to the 'Oracle of Omaha' Warren Buffet, it pays to be fearful when others are exhibiting greed and to be greedy when the market is full of fear. This is good advice, but in practice a lot harder to perfect than it might seem.

As you can see, the fear and greed index is a handy tool that can greatly impact your trading and investing decisions. Used in conjunction with other technical analysis, it can radically change your investment decision-making.

However, as with any form of investing, it is imperative that you conduct due diligence before making any financial decisions.